Wells Fargo & Company Annual Report 2005

Plain-text annual report

How Do We Picture the Next Stage of Success? Wells Fargo & Company Annual Report 2005 3 To Our Owners Wells Fargo & Company Reputation For 20 years, Wells Fargo has achieved double-digit growth in almost every economic environment. Chairman/CEO Dick Kovacevich explains how our team did it. 11 How Do We Picture the Next Stage of Success? We believe—and many industry observers agree—that we have the strongest management team in all of ﬁnancial services. Here’s how they picture success for their customers, their businesses and their teams. 24 Picturing the Next Stage of Success for Our Communities We’re one of corporate America’s top 10 givers—but it’s the time, talent and creativity of our team member volunteers that really sets us apart. 31 Board of Directors, Senior Management 33 Financial Review 58 Controls, Procedures 60 Financial Statements 112 Report of Independent Registered Public Accounting Firm 116 Stockholder Information Which Measures Really Matter? 2005 Update (inside back cover) Barron’s World’s most admired ﬁnancial services company Business Ethics Ranked top 10 corporate citizen BusinessWeek Among corporate America’s top 10 corporate givers Fortune “Most Admired Megabank” 52nd in revenue among all U.S. companies in all industries World’s 29th most proﬁtable company Mergent, Inc. “Dividend Achiever”* Moody’s Investors Service Only U.S. bank rated “Aaa,” highest possible credit rating Watchﬁre GomezPro #1 internet bank Wells Fargo & Company (NYSE: WFC) is a diversiﬁed ﬁnancial services company providing banking, insurance, investments, mortgage loans and consumer ﬁnance. Our corporate headquarters is in San Francisco, but we’re decentralized so all Wells Fargo “convenience points”—including stores, regional commercial banking centers, ATMs, Wells Fargo Phone BankSM centers, internet—are headquarters for satisfying all our customers’ ﬁnancial needs and helping them succeed ﬁnancially. “Aaa” Wells Fargo Bank, N.A. is the only U.S. bank to receive the highest possible credit rating from Moody’s Investors Service. Assets: $482 billion (5th among U.S. peers) Market value of stock: $105 billion (4th among U.S. peers) Fortune 500: Proﬁt, 17th; Market Cap, 18th Team members: 153,500 (one of U.S.’s 40 largest private employers) Customers: 23+ million Stores: 6,250 * Publicly traded companies that increased dividends for last 10+ consecutive years; Wells Fargo has increased dividends for 18 consecutive years, 23 increases since 1988. Our Earnings Diversity Community Banking . . . . . . . . . . . . . 34% Home Mortgage/Home Equity . . . 20% Investments & Insurance . . . . . . . . . 15% Specialized Lending . . . . . . . . . . . . . . 15% Wholesale Banking/ Commercial Real Estate . . . 9% Consumer Finance . . . . . . . . 7% Earnings based on historical averages and near future year expectations Our Market Leadership #1, 2 or 3 in deposit market share in 15 of #1 agricultural lender our 23 banking states; #4 nationally (6/30/05) #1 retail mortgage originator; #2 mortgage servicer #1 ﬁnancial services provider to middle-market businesses in our banking states #2 in mortgages to low-to-moderate income #2 debit card issuer home buyers #1 home equity lender #1 small business lender #2 bank auto lender #3 ATM network One of U.S.’s leading commercial #1 small business lender in low-to-moderate real estate lenders income neighborhoods #1 insurance broker owned by bank holding company (world’s 5th largest insurance brokerage) One of North America’s premier consumer ﬁnance companies Banking, insurance, investments, mortgage loans, and consumer ﬁnance— we span North America and beyond. How Do We Picture the Next Stage of Success? Our vision—as it has been for 20 years—is to satisfy all our customers’financial needs and help them succeed financially. A vision by itself, however, is not enough.You must have a plan to achieve that vision and a time-tested business model that can perform successfully in any economic cycle.You have to execute against that plan efﬁciently and effectively. In fact, it’s all about execution. To be successful, you need leaders who can establish, share and communicate that vision, motivate others to embrace, believe in and follow that vision, and execute in a superior fashion each day, every day, one customer at a time. (l to r): Karen Johnson-Norman, Commercial Real Estate Group, Washington, DC; Christian Chan, Wells Fargo Funds, San Francisco, California; Edgar Ramirez, Payment Operations, Irving,Texas; Dick Kovacevich, Chairman and CEO; Amy McSpadden, Wells Fargo Financial, Alpharetta, Georgia 2 To Our Owners, This year’s outstanding results prove it once again.We have the most talented, professional, caring, committed, ethical, “customer first”team in all of financial services. Guided by our vision, values, our time-tested business model, our diversity of businesses and our conservative risk management —all in place for 20 years—our team once again produced outstanding, industry-leading results.That included double- digit growth in revenue and earnings per share—which we achieved not just this year, but also for the past 20, 15, 10 and five years. Over all these periods, our total stockholder return was about double the S&P 500®. Amazing! It’s all the more amazing because our team achieved these record results the past 20 years, while dealing with almost every economic cycle and every economic condition a ﬁnancial institution can experience. High and low interest rates. Bubbles and recessions. All types of yield curves (steep, ﬂat and inverted). High and low unemployment. No one can accurately predict how the economy will perform in 2006 or in any year but for Wells Fargo to achieve double-digit growth we must continue to focus on our primary strategy, consistent for 20 years, which is to satisfy all our customers’ ﬁnancial needs, help them succeed ﬁnancially, and through cross-selling, gain wallet share and earn 100 percent of their business. Among our 2005 achievements: • Revenue growth of 10 percent—double-digits once again— the most important measure of success in our industry— outpacing our single-digit expense growth. • Diluted earnings per share—a record $4.50, up 10 percent— despite the $0.07 per share cost for increased bankruptcy ﬁlings before the October change in federal bankruptcy laws. • Net income—a record $7.7 billion, up 9 percent. • Our stock price reached a record high close of $64.34 on November 25, 2005. 3 Our Performance Double-digit growth: earnings per share, revenue, loans and retail core deposits $ in millions, except per share amounts 2005 2004 Change $ 7,671 4.50 $ 7,014 4.09 9% 10 FOR THE YEAR Net income Diluted earnings per common share Proﬁtability ratios Net income to average total assets (ROA) Net income applicable to common stock to average common stockholders’ equity (ROE) Efﬁciency ratio 1 Total revenue Dividends declared per common share Average common shares outstanding Diluted average common shares outstanding Average loans Average assets Average core deposits 2 Average retail core deposits 3 Net interest margin AT YEAR END Securities available for sale Loans Allowance for loan losses Goodwill Assets Core deposits 2 Stockholders’ equity Tier 1 capital Total capital Capital ratios 1.72% 1.71% 19.57 57.7 19.56 58.5 $ 32,949 $ 30,059 2.00 1,686.3 1,705.5 $296,106 445,790 242,754 201,867 1.86 1,692.2 1,713.4 $269,570 410,579 223,359 183,716 4.86% 4.89% $ 41,834 310,837 3,871 10,787 481,741 253,341 40,660 31,724 44,687 $ 33,717 287,586 3,762 10,681 427,849 229,703 37,866 29,060 41,706 1 — (1) 10 8 — — 10 9 9 10 (1) 24 8 3 1 13 10 7 9 7 (5) (2) (4) (1) 8 5 Stockholders’ equity to assets 8.44% 8.85% Risk-based capital Tier 1 capital Total capital Tier 1 leverage Book value per common share Team members (active, full-time equivalent) 8.26 11.64 6.99 8.41 12.07 7.08 $ 24.25 $ 22.36 153,500 145,500 1 The efﬁciency ratio is noninterest expense divided by total revenue (net interest income and noninterest income). 2 Core deposits are noninterest-bearing deposits, interest-bearing checking, savings certiﬁcates and market rate and other savings. 3 Retail core deposits are total core deposits excluding Wholesale Banking core deposits and retail mortgage escrow deposits. 4 Our primary strategy, consistent for 20 years, is to satisfy all our customers’ financial needs, help them succeed financially, and through cross-selling earn 100 percent of their business. • At year-end, the total value of our stock was $105 billion— • We funded $366 billion in mortgages—our second highest again making us one of the nation’s 20 most valuable companies. • Return on equity, 19.57 percent; return on assets, 1.72 percent. • Our credit quality remained excellent. Nonperforming loans were at or near historic lows. • Fortune ranked Wells Fargo “Most Admired Megabank”; Barron’s ranked us the world’s most admired ﬁnancial services company and we continue to be the only U.S. bank with the highest possible credit rating, “Aaa.” • Community Banking achieved record proﬁt of $5.53 billion, up 13 percent with revenue increasing nine percent. • In consumer banking, we sold almost 16 million products (or “solutions”)—checking, savings, debit cards, loans, etc.— to our customers, up 15 percent. • Our loans to small businesses, primarily less than $100,000, grew 18 percent. For the third consecutive year, we were the nation’s #1 small business lender in total dollars. In the past 10 years, we’ve loaned more than $26 billion to small businesses owned by African-Americans, Asian-Americans, Latinos and women, exceeding our publicly-stated goals. • For the seventh consecutive year, our cross-sell reached record highs—4.8 products per retail banking household, 5.7 products per Wholesale Banking customer. Our average middle-market, commercial banking customer now has almost 7.0 products with us—up from almost ﬁve just two years ago. In fact, more than one of every ﬁve of our commercial banking ofﬁces nationwide averaged eight products per customer. • For the seventh consecutive year, Wholesale Banking achieved record net income of $1.73 billion—with double-digit loan growth this year across its businesses. • Our Wholesale Banking business now is truly coast-to-coast, with more than 600 ofﬁces nationwide. Across the Eastern U.S., we have 175 ofﬁces for commercial banking, commercial real estate, corporate banking, asset-based lending and equipment ﬁnance. We’re attracting new commercial customers in markets such as Atlanta, Boston, Cleveland, Hartford (Conn.), Indianapolis, New York and Tampa. annual total ever—and continued to be the nation’s #1 retail mortgage originator. Our owned mortgage servicing portfolio, the nation’s second largest, rose 23 percent to $989 billion. The housing market remained strong because new home construction continued to lag the pace of new household formation. • Our National Home Equity Group’s loans were $72 billion at year-end with continued very strong credit quality—ranking us the nation’s #1 home equity lender for the fourth consec- utive year. • Wells Fargo Financial—our consumer ﬁnance business— grew average receivables 25 percent. • Watchﬁre GomezPro ranked Wells Fargo internet banking #1 among all U.S. banks. Global Finance magazine named wellsfargo.com best in the U.S. in six categories including “best corporate/institutional internet bank.” Information technology magazine CIO named Wells Fargo one of its 100 Bold winners for our innovative Commercial Electronic Ofﬁce® (CEO®) portal, now used by almost three-fourths of our commercial customers for everything from loan payments to foreign exchange. Top 10 Consumer Internet Banks 1. Wells Fargo 2. Citibank 3. Bank of America 4. E*Trade Bank 5. Huntington Source: Watchﬁre GomezPro, 3Q05 6. First National Bank of Omaha 7. HSBC 8. U.S. Bank 9. Chase 10. Wachovia • To be the ﬁnancial services company of choice for remittance customers, we expanded that service beyond Mexico, India and the Philippines into El Salvador and Guatemala. The number of accounts we opened for Mexican Nationals using the Matricula Consular card as a form of identiﬁcation surpassed 600,000. We were the ﬁrst ﬁnancial institution in the nation to promote the use of this card as a form of 5 Double-Digit Annual Compound Growth – for 20 Years Years 5 10 15 20 EPS Revenue 14% 10% 11 12 14 13 12 12 5% Total Stockholder Return Wells Fargo S&P 500® 0.5% 9 11 12 17 21 21 identiﬁcation to help these customers move from the risky, cash economy to secure, reliable ﬁnancial services. • In Los Angeles and Orange counties, we launched a pilot program to offer mortgage loans to employed, taxpaying cus- tomers who have an individual taxpayer identiﬁcation number (ITIN) issued by the IRS but do not have a Social Security number.1 If successful, we hope to roll this mortgage product out across all 23 of our community banking states. • We increased the Company’s quarterly dividend more than 8 percent to 52 cents a share, the 18th consecutive year we’ve increased our dividend, our 23rd dividend increase since 1988. We’re the nation’s 13th largest dividend payer and one of less than 3 percent of more than 10,000 North American-listed, dividend-paying common stocks classiﬁed as a “Dividend Achiever”—a publicly-traded company that has increased its dividends for the last 10 or more consecutive years.2 If you had invested $10,000 in 1986 in our predecessor company, Norwest Corporation, it would have been worth $435,000 at year-end 2005 with dividends reinvested. • Our total managed and administered assets rose 6 percent to $880 billion. The new Wells Fargo Advantage FundsSM— the result of the merger of Wells Fargo Funds® and Strong Funds®—is the nation’s 18th-largest mutual fund company, managing $108 billion in assets, with 120 funds spanning almost all asset classes and investment styles. • We announced a 10-point commitment to integrate environmental responsibility into our business practices. This includes a pledge to provide more than $1 billion in the next ﬁve years, in lending, investments and other ﬁnancial commitments to environmentally-beneﬁcial business oppor- tunities including sustainable forestry, renewable energy, water-resource management, waste management, “green home” construction and development, and energy efﬁciency. 1 Qualiﬁed individuals must have been customers of Wells Fargo Bank for six months, paid U.S. taxes for two years, must be able to prove two years of California residence. 2 Mergent, Inc. 6 Impressive results, indeed. We’re very proud of them. But, believe it or not, we can do even better. In recent annual reports, we told you that we’ve not been growing our business banking and investment businesses at a rate consistent with their potential. I’m pleased to report we’re making signiﬁcant progress. Business Banking Just two years ago, our average Business Banking customer— businesses with annual revenue up to $20 million—had only about 2.7 products with us—dead last in cross-sell among all our businesses. Also, less than one of every four of our Business Banking customers did their personal banking with Wells Fargo. Less than one of every 10 gave us their investment business. Two years ago we said that by 2008 we wanted to double rev- enue and cross-sell and dramatically increase our market share for both deposits and loans from our small business customers. I’m pleased to report that our Business Banking cross-sell grew 11 percent for the year. Our Business Banking team surpassed an average of 3.0 products (or “solutions”) per customer. The number of business customers actively using online banking grew 24 percent. Our Business Banking deposits—which grew 10 percent in 2004—rose another 9 percent in 2005. During those same years our loans and lines of credit—primarily less than $100,000, sold to our small business customers through our banking stores, online, direct mail, teleconsulting and in-bound calls—rose 17 percent and 18 percent, respectively. Our business customers are buying their ﬁnancial products from someone. Since we believe we can offer them a superior value, there’s no reason we shouldn’t earn all their ﬁnancial services business—business, personal and investments. In 2004 Wells Fargo was #1 for the third year in a row in loans under $100,000 to small businesses, with 15 percent market share nationally. We also were the #1 lender to small businesses in low-to-moderate income neighborhoods, with almost 16 percent market share, nationwide. Wells Fargo has achieved double-digit, annual compound growth in revenue and earnings per share, with total stockholder return about double the S&P 500 for the past five, 10, 15 and 20 years. Top 10 U.S. Full-Service Online Brokers 1. Smith Barney 2. Wells Fargo 3. UBS 4. Wachovia 5. Merrill Lynch 6. Piper Jaffray 7. DB Alex Brown 8. A.G. Edwards 9. McDonald Investments 10. Edward Jones Source: Watchﬁre GomezPro 10/31/05 Private Client Services Our private banking and investment business—Private Client Services—also is growing. It ended 2005 with double-digit revenue growth in the fourth quarter. We built the foundation for this growth by integrating all banking, investment and insurance services to serve all of our clients’ wealth management needs. We’ve signiﬁcantly increased the number of investment professionals serving clients. We now have more than 700 private bankers in our banking stores and wealth management ofﬁces, up 150 percent the past two years—and 2,500 licensed bankers and ﬁnancial consultants, up more than 85 percent in three years. In 2005, we were the ﬁrst in our industry to announce low- and no-cost online stock and mutual fund trades to beneﬁt our most loyal customers. Watchﬁre GomezPro ranked us the nation’s second best, full-service on-line brokerage. As a result, we’re earning more of our clients’ business. Our loans to Private Banking customers grew 15 to 20 percent each of the last ﬁve years. The last two years, deposits rose 38 percent, and brokerage assets 14 percent. More than one million of our customers now have a Wells Fargo Portfolio Management Account®, or PMA® account—which combines all a customer’s relationships with Wells Fargo, including checking, savings, mortgage, personal loans, trust and brokerage. This relationship product offers rewards, discounts, competitive money market rates, bonus interest rates on linked savings accounts and CDs, no monthly service fees on linked accounts, a Wells Fargo Visa® Credit Card with waived fee for the Retention Rewards® program, no annual fees on select line of credit accounts, free checks, and commission discounts with a linked WellsTrade® account. In just ﬁve months, balances across all our deposit and brokerage accounts increased over $4 billion. Our Investment Management and Trust businesses are growing, too. In addition to more basic wealth planning services—such as trust and estate services — we’ve added alternative asset classes and we’re offering “best of class” outside money managers for our high net worth clients. They, in turn, have given us more of their business. As a result, we’ve achieved ﬁve consecutive quarters of record sales, a 40 percent increase in revenue year over year from wealth planning and insurance. Good progress but, here again, we can and must do better, faster. Our market share of our customers’ investment business should be two to three times higher than it is. There’s no reason why we can’t attract many more new customers. More of our Private Banking and Personal Trust customers should want to give us their investment management and brokerage business. We also should be satisfying more of the investment needs of our small business customers and the executives of our middle-market, real estate, and large corporate customers. We should be their ﬁrst choice for personal investment and banking business. Preparing for more growth We continue to invest in new stores and operation centers to help satisfy all our customers’ ﬁnancial needs. During 2005, we opened 92 banking stores, remodeled another 485 banking stores to improve customer service, and opened 47 mortgage stores, 20 consumer ﬁnance stores, seven regional commercial banking ofﬁces and two commercial real estate ofﬁces. We also completed four major operations facilities (and are about to complete a ﬁfth): • West Des Moines, Iowa Our mortgage and consumer credit group opened a 281,000 square foot center for about 1,500 team members. Two more buildings are scheduled to open in mid-2006 and in 2007—for a total of almost one million square feet—on a 160-acre campus, large enough to accom- modate even more expansion. 7 “At Wells Fargo, we’re fortunate to have what I believe—and many industry observers agree—is the best team of senior leaders in the entire financial services and banking industry.They lead with integrity.They know how to build high-performing teams.They all own the customer experience—together.” • Des Moines, Iowa Later in 2006 Wells Fargo Financial is scheduled to complete a 360,000 square foot, nine-story building for 1,500 team members, connected via skyway to its downtown headquarters; • Minneapolis, Minnesota A $175 million conversion and expansion of the former Honeywell Campus near downtown Minneapolis. It consolidates a dozen Twin Cities area mortgage operations centers and is expected to accommodate about 4,600 team members by year-end 2006; • Shoreview, Minnesota A new 160,000 square foot data center in a northern Twin Cities suburb; • Chandler, Arizona A new operations, technology and call center campus near Phoenix has two, 200,000 square foot, four-story buildings, now home to about 2,100 team members in operations and technology. This site is large enough to accommodate four more buildings totaling 800,000 square feet. The quality of our leadership Our vision—as it has been for 20 years—is to satisfy all our customers’ ﬁnancial needs and help them succeed ﬁnancially. A vision by itself, however, is not enough. You must have a plan to achieve that vision and a time-tested business model that can perform successfully in any economic cycle. You have to execute against that plan efﬁciently and effectively. In fact, it’s all about execution. To be successful, you need leaders who can establish, share and communicate the vision, motivate others to embrace, believe in and follow that vision, and execute in a superior fashion each day, every day, one customer at a time. At Wells Fargo, we’re fortunate to have what I believe— and many industry observers agree—is the best team of senior leaders in the entire ﬁnancial services and banking industry. They’re the CEOs of our diverse businesses—spanning virtually every segment of our industry. They’re responsible. They’re accountable. They and their teams have produced outstanding results you’ve come to expect from Wells Fargo year after year after year. They partner together unselﬁshly. Each and every one is a great coach. They realize, as every great coach does, that 8 success is not about their own self-interest. It’s about what’s best for their teams, their customers and their partners in other Wells Fargo businesses. They give their teams the tools, training and resources they need to achieve our goal of industry-leading, double-digit growth in revenue, proﬁt and earnings per share. They help create our vision and values. They help us achieve our vision every day with every customer. They cause our success to happen. They drive our business results. They inﬂuence, direct and inspire their teams. They make sure our 153,000 team members understand, support and live that vision and those values. They’re role models for leadership. They lead with integrity. When they make a mistake, they accept responsibility and learn from it. They’re big picture thinkers with a broad perspective—company-wide and industry-wide. They’re open to new ideas, know how to learn and they learn from each other and share best practices. They’re mentors for emerging, diverse management talent across the company. They’re collaborators. They know how to build high-performing teams. They and their teams have fun together. They thrive on change. They care about their people. They value diversity. They all own the customer experience—together. They’re not just good leaders, they’re great leaders. What’s the difference? A good leader inspires a team to have conﬁdence in her or him. A great leader inspires a team to have conﬁdence in themselves. They teach and coach others to lead. Most of all, they believe in our most important value: people as a competitive advantage. They make every business decision with that value in mind. They know that somewhere on their teams is the answer to every problem, challenge and opportunity. Their job is to ﬁnd the people on their teams who have the answers, regardless of rank or stripes, and help translate those answers into action. The people with the answers most often are those closest to our customers. How do we picture the next stage of success? Therefore, in our report to you this year, we want you to get to know this great team of senior business leaders better. We want you to fully appreciate, as I do, their outstanding talent, skill, experience, integrity, ethics, innovation, insight and caring— and how they picture success for their businesses in the coming years. Beginning on page 11, our leaders describe their vision of success for their businesses, how they and their talented teams intend to partner to grow market share and wallet share, and earn all of our customers’ business. I’m very fortunate to be playing with the best team in ﬁnancial services. I’m very proud to share their stories with you in this report. The National Bank Act—the law of the land Mobility is a way of life for most of our more than 23 million customers. They commute, do business, relocate, travel and vacation, often coast to coast. Many have a second home in different states. They buy goods and services globally. When it comes to commerce, state boundaries are meaningless for them. They assume that anywhere they go in the United States (or the world) they can access their money, make ﬁnancial transactions and get information about their accounts through their national bank governed by uniform, consistent federal oversight. Thanks to this national oversight, they can receive credit decisions almost instantly, a mortgage in just a few days. They take this national freedom of ﬁnancial access for granted. But it’s not a birthright. It’s the result of a series of laws and court decisions going back almost a century and a half. The most important of those laws, by far, is the National Bank Act of 1864. This visionary law—enacted just 12 years after our company was founded—brought economic order out of a costly, chaotic patchwork of state laws. It created uniform national standards for safety and soundness governing an association of national banks with national charters. When the telegraph was the internet of its day, this law encouraged the free ﬂow of capital and labor across state lines in an increasingly mobile society. It created the federal Ofﬁce of the Comptroller of the Currency and gave it exclusive powers to examine national banks such as today’s Wells Fargo Bank, N.A. States could still regulate state banks. The federal government would regulate national banks. Unfortunately, the last few years several states have tried to turn back the clock and challenge the authority of the Comptroller to set uniform federal law for national banking and to supervise, exclusively, national banks and their operating subsidiaries. One Nation. One Economy. Consistent National Standards. Here are just six recent rulings that each upheld the principle that the National Bank Act preempts state attempts to regulate national banks—whether a state does this by restricting their banking activities or through regulatory supervision: January 2006 The U.S. Supreme Court, in an 8-0 ruling, holds that relevant federal banking laws do not deny national banks the right to have cases heard in federal court merely because the bank does business in a partic- ular state. Justice Ruth Bader Ginsburg wrote in the ruling that a lower court ruling was wrong because national banks would be “singularly disfavored” in their access to federal courts. October 2005 Federal District Court rules in favor of a ﬁnancial services trade association. It blocks the New York Attorney General’s Ofﬁce from demanding information from national banks and investigating their lending practices.The Court rules that the National Bank Act preempts state investigations of this type over a national bank such as Wells Fargo Bank, N.A., leaving such oversight to national regulators such as the Ofﬁce of the Comptroller of the Currency and the Federal Reserve Board. August 2005 Federal Ninth Circuit Court of Appeals rules in favor of Wells Fargo. It holds that the National Bank Act preempts state licensing requirements and state supervisory authority over national bank subsidiaries. The California Department of Corporations had tried to exercise authority over Wells Fargo Home Mortgage, Inc., part of Wells Fargo Bank, N.A. July 2005 A Federal Circuit Court of Appeals holds that the National Bank Act preempts state regulation of a national bank’s operating subsidiary. The case arose when a national bank and its mortgage subsidiary sued the State of Connecticut to avoid having to obtain a state license and follow certain state laws. February 2003 Federal Fifth Circuit Court of Appeals rules in favor of Wells Fargo and other national banks. It holds that the National Bank Act preempts state laws that ban certain check-cashing fees to non-customers. October 2002 Federal Ninth Circuit Court of Appeals rules in favor of Wells Fargo and other national banks. It holds that the National Bank Act preempts local ordinances that try to stop national banks from charging non-customers a convenience fee for using their ATMs. San Francisco and Santa Monica had ordinances to prohibit these fees. 9 Fortunately for our customers, every single one of these misguided attempts has failed. When states and local governments announce these lawsuits, they often attract signiﬁcant media coverage. But when they’re adjudicated in the courts—which have consistently ruled in favor of national banks on these issues— the stories are buried or not reported at all. 2006: The Economy This coming year will be challenging for the banking industry. Asset yields do not seem to account for risk. Credit quality can’t get much better. The yield curve—the difference between short-term and long-term interest rates—is likely to be ﬂat, even inverted. Banking competitors are, once again, relaxing loan terms while not fully pricing for this risk. However, Wells Fargo’s business model, now in place for nearly 20 years, focuses on selling more products to existing customers and, therefore, gaining both market share and wallet share. Perhaps that’s why Wells Fargo produced consistent double-digit increases in both revenue and earnings per share over the past 20, 15, 10 and ﬁve years, which included almost every economic condition a ﬁnancial institution can face, not unlike those that may exist in 2006. The Next Stage Once again, we thank our 153,000 talented team members for their outstanding accomplishments and record results not just for this year but for the past 20 years. We thank our customers for entrusting us with more of their business and for returning to us for their next ﬁnancial services product. We thank our communities—thousands of them across North America— that we partner with to make them better places to live and work. And we thank you, our owners, for your conﬁdence in Wells Fargo as we begin our 155th year (March 1852). A special thank you Two members of our Board will retire this April after a total of three decades of service to our company. Dr. Reatha Clark King, retired president and board chair of the General Mills Foundation, Minneapolis, Minnesota, joined the Board 20 years ago when the former Norwest Corporation had assets of just over $21 billion. Most recently she served on the audit and examination, and the ﬁnance committees. Gus Blanchard, chairman of ADC Telecommunications, Inc., Eden Prairie, Minnesota, joined our Board 10 years ago, when we had assets of just over $80 billion. Most recently, he served on the audit and examination, credit, and governance and nominating committees. Their wise counsel and thoughtful guidance has helped our company achieve remarkable growth during their tenures while we built a reputation as one of the world’s most admired ﬁnancial services companies. Thank you, Reatha and Gus! The “Next Stage” of success is just down the road—for our team members, our customers, our communities and our stockholders. It’s going to be a great ride! Richard M. Kovacevich, Chairman and CEO 1 0 How Do We Picture the Next Stage of Success? Each of our senior leaders has a vision for the future success of their businesses—how they and their talented teams intend to partner to grow market share and earn all of their customers’ business.As you can see on the following pages, they’re unanimous on one key point—people as a competitive advantage. (l to r): Howard Atkins, Senior EVP, Chief Financial Ofﬁcer; Dave Hoyt, Senior EVP, Wholesale Banking; John Stumpf, President and Chief Operating Ofﬁcer; Mark Oman, Senior EVP, Home and Consumer Finance 1 1 John Stumpf, President and Chief Operating Ofﬁcer Years in ﬁnancial services: 30 Star of Our Team: The Team! “The way our team partners together, cares about each other, cares about customers and solves their ﬁnancial needs is rare in any company.‘Culture’ makes it happen. It’s instinctive. It’s knowing the right thing to do without having to be told. Financial services is very complex. Our company has more than 80 businesses, so winning all our customers’ business is a team sport.The star of our team… is the team! We’re a circle not a hierarchy. At the center of the circle—our customers. Alongside them—our customer-contact team members. Farther out in the circle are our managers. At the outside of the circle are senior managers like me. All of us partner together to do the best job we can for our customers. (l to r): Patti Hoversen,Technology Information Group, Minneapolis, Minnesota; Lori LoCascio, Wells Fargo Phone Bank, Lubbock,Texas; John Stumpf If we grow the top line—revenue—the bottom line takes care of itself.We’re not just expanding our franchise, we’re expanding our thinking.We’re not just adding new stores, we’re adding more team members to serve and sell our customers and offer them the best solutions. Our success is the result of habits and focused execution, not random acts. Our people are our competitive advantage. Our product is service. Our value-added is advice. Our customers come to us because of what we know, so they can learn how to save time and money. If we think like a customer and focus our team on serving customers, then everyone beneﬁts.” 1 2 Dave Hoyt, Senior EVP, Wholesale Banking Years in ﬁnancial services: 28 Knowing How to Serve and Sell “Our picture of success begins with talented people. Our customers think of them ﬁrst when they think of Wells Fargo. Diverse, seasoned leaders who make decisions locally, close to the customer. Our relationship managers make sure we completely understand the customer’s needs before we offer any products to satisfy their ﬁnancial needs.The scope of our group is amazing—55 national businesses, coast to coast, revenue the equal of a Fortune 350 company, as impressive an array of products and services as you’ll ﬁnd anywhere. Team members: 15,000 Customers: 78,000 Locations: 600 Products per customer: 5.7 (l to r): Dave Hoyt; Patti Rosenthal, Wholesale Services, San Francisco, California; Ray Orquiola, Wholesale University, San Francisco, California We know how to serve and sell—we lead the company in products per customer. For example, we deliver credit products many different ways—a straight commercial loan, an asset-based loan, a commercial mortgage loan, a franchisee loan, a loan for equipment-ﬁnance or equipment-leasing, or a private placement or a syndicated credit. Almost three of every four of our customers now use our internet portal—Commercial Electronic Ofﬁce—to run their business more efﬁciently. It continues to be the best in the industry. Customers sign on just once to access more than 40 products. Our new Desktop DepositSM service lets customers make deposits electronically from their own ofﬁce, no more hauling paper to our banking stores.“ 1 3 Mark Oman, Senior EVP, Home and Consumer Finance Years in ﬁnancial services: 26 Turning Vision into Reality “Our team serves virtually all the credit needs of individual customers—mortgage loans, home equity loans, personal credit, and consumer ﬁnance. So, success for us is satisfying all these needs smoothly for our customers whether it’s through our stores, on the phone or via the internet.We span all 50 states, Canada and parts of the Caribbean, and we’re #1 nationally in many products, but our market share is still relatively small.That gives us lots of opportunity for future growth. A mortgage is the largest, most complex ﬁnancial transaction most of our customers ever make. It’s also a core product— customers value it so much they’re more likely to give us even more of their ﬁnancial services business—not just home equity loans and banking products but their investments and insurance. Team members: 52,000 Customers: 12.3 million Stores: 2,388 (l to r): Mark Oman; Phil Hall, Home and Consumer Finance, Des Moines, Iowa; Michael Levine, Wells Fargo Home Mortgage, Minneapolis, Minnesota We’ve proven this works: cross-sell among our mortgage customers has grown about 30 percent a year for the last several years. Our mortgage business is the Company’s second largest source of checking accounts and new credit card customers. Our group accounts for almost two of every three of Wells Fargo’s new customers.We’ll be even more successful when we can earn more business from our consumer ﬁnance customers. We service the mortgage and home equity loans of more than ﬁve million households.That’s a monthly relationship that positions us to be there when they need their next ﬁnancial product.We also have to be best at managing risk.We can’t avoid all risk and still make a proﬁt. It’s how well we manage interest-rate risk, credit risk, operations risk and compliance risk that makes the difference.” 1 4 Howard Atkins, Senior EVP, Chief Financial Ofﬁcer Years in ﬁnancial services: 31 Consistency “Our ﬁnancial success begins with our time-tested business model. More than 80 businesses.We cover virtually every facet of ﬁnancial services.This diversity gives us 80 different ways to grow, helps us manage the risk of unforeseen changes in the economy or ﬁnancial markets, and helps us earn more business from our customers wherever they are in their ﬁnancial life cycle. Success for us also means excelling at managing risk in asset quality, interest rates, accounting and operations, and capital. Our credit ratings are very high. Our approach to risk has always been very disciplined.We don’t take unacceptable risks even if some competitors are willing to do so.We’re consistent—with our customers and with Wall Street. As good as our business model and track record is, however, our strong and consistent ﬁnancial results cannot happen without…great people! I believe we have the best in the industry.” Team members: 1,200 Finance, Corporate Development, Investor Relations, Treasury, Corporate Properties, Investment Portfolio, Controllers (l to r): Howard Atkins; Nancy Lee, Investor Relations, San Francisco, California; Cindy Garcia, Corporate Properties, Phoenix, Arizona 1 5 Carrie Tolstedt, Regional Banking Years in ﬁnancial services: 20 Clyde Ostler, Private Client Services (PCS), Internet Services Years in ﬁnancial services: 35 Energized, Diverse, Caring Great Service Every Time “Our success begins with our great team.When our diverse and caring team is doing what they do best, they connect with our customers to create a special relationship that lasts a lifetime. Our engaged team is the link between our vision and the customer experience. Supported by talented leaders in our local markets, our team responds quickly to their customers, on the spot, doing what’s right for them.They know their stores, their customers and communities better than anyone. We develop tools centrally to support our team—training, measurement, marketing, reporting, products and systems.We want to earn 100 percent of our customers’ business by partnering with other teams, such as Home Mortgage, Private Client Services and Wells Fargo Financial. Our customers are at the center of everything we do. Our team is our competitive advantage.” “Our picture of success for Private Client Services is very simple— exceptional service for each client every time.We start with the client’s aspirations, goals, and the legacy they want to leave for future generations. Our value-added is our ﬁnancial advice. Our team of professionals should understand our clients’ﬁnancial needs so well—and deliver such great service—that they will want to bring all their business to Wells Fargo. Partnering with our banking store teams, we provide investment and insurance services by putting our customers’ needs ﬁrst, and giving them great, individual service and advice that distinguishes us from our competitors. We’re rated America’s best internet bank, but we measure internet success by what our customers tell us—and they tell us they appreciate the convenience and beneﬁts of wellsfargo.com by giving us more of their business.” Team members: 51,000 Households: 10.3 million Stores: 3,120 (92 opened in ’05) Products per customer: 4.8 (l to r): Carrie Tolstedt; Joey Davis, Regional Banking, Omaha, Nebraska; Laurie Doretti, Regional Banking, Scottsdale, Arizona Team members: 8,000 PCS clients: 820,000 Active online consumers: 7.1 million #1 consumer internet bank (l to r): Katie Kellen, PCS, Denver, Colorado; Clyde Ostler; Lisa Robinson, Internet Services, San Francisco, California 1 6 Mike James, Diversiﬁed Products Years in ﬁnancial services: 33 Trusted Advisors “We’re a diverse group of businesses that share one vision for success—to help our team members and customers achieve their goals. For team members, this means knowing how their work connects to the Wells Fargo vision, knowing they have the tools, work environment and partnering spirit to go as far as their talent and skill can take them. For customers, it means helping them achieve ﬁnancial success. Having the right products and services is important, but to satisfy all our customers’ ﬁnancial needs we have to build relationships with them, as trusted advisors, so they’ll want to give us all their business.” Pete Wissinger, Insurance Years in ﬁnancial services: 30 Insurance: Core Product “To succeed as an insurance provider we must be consistently superior in helping customers identify their speciﬁc risks, understand their insurance choices, select cost-effective protection, and be comfortable with their choice. Success in all of these helps them, and us, be ﬁnancially successful. Like checking, investments and a mortgage, insurance is a core Wells Fargo product: when customers buy it from us they’re more likely to buy more products from us.That’s why we’re a full-service provider of insurance solutions through our insurance agencies, banking stores, phone, mail and internet. We’re the world’s ﬁfth largest insurance brokerage company, and America’s largest crop insurance provider—but we have unlimited potential for growth and more success. Only four percent of our banking customers buy their insurance through us!” Team members: 5,000 #1 U.S. small business lender #2 U.S. debit card issuer Student loan customers: 1 million (l to r): Ciony Catangui, Education Finance Services, Sioux Falls, South Dakota; Danny Ayala, Global Remittances,Concord,California; Mike James Team members: 2,000 Customers: 300,000 World’s 5th largest insurance broker #1 U.S. crop insurer #1 bank-owned insurance agency (l to r): Pete Wissinger; John Tebbs, Rural Community Insurance Services, Winchester, Kentucky; Paul Gauro, Wells Fargo Insurance, Minneapolis, Minnesota 1 7 Iris Chan, Commercial Banking Years in ﬁnancial services: 30 Tim Sloan, Specialized Financial Services Years in ﬁnancial services: 21 Growing with Customers Ringing the Bell “Our business is all about relationships.If we earn our customers’trust then they’ll rely on us as their ﬁnancial institution and we can earn all their business.We offer valued advice to deepen every relationship, to help every customer be ﬁnancially successful. Relationship managers are key in building successful partnerships. Our talented team of bankers is trained and equipped with extensive product knowledge. We know our customers well.We listen and respond by customizing speciﬁc solutions tailored to each customer’s ﬁnancial needs.We anticipate challenges and design solutions they may not have even thought about.The more they value our relationship, the more resources we can provide them—credit for their operations, a term loan for capital expenditures or acquisitions, investment alternatives, insurance solutions, or treasury management.When our customers succeed, we succeed.” “We’re a diverse, complex group—22 businesses and 150 locations nationwide. Our team members do everything from making loans and leases to investing in securities and providing capital markets advice.Our customers range from tribal governments and local school districts to real estate developers and Fortune 1000 companies. Our picture of success: understand our customers’ businesses better than anyone else and offer them great ideas and sophisticated solutions so they can be more successful.We ring the bell when we help create value for them.” Team members: 1,100 Customers: 8,200 #1 ﬁnancial services provider to middle-market companies in western U.S. (l to r): Richard Gan, Commercial Banking, Austin,Texas; Iris Chan; Gary Dyshaw, Commercial Banking, St. Paul, Minnesota Team members: 1,800 Customers: 33,000 Assets: $30 billion (l to r): Alex Idichandy, Corporate Banking, Atlanta, Georgia; Kristine Netjes, Media Finance, Minneapolis, Minnesota; Tim Sloan 1 8 Mike Niedermeyer, Asset Management Years in ﬁnancial services: 22 Results Peter Schwab, Asset-Based Lending Years in ﬁnancial services: 30 Staying Flexible “Success happens when we deliver terriﬁc results for our clients and help them meet their investment goals.When we do that, they entrust us with even more of their money.The more high quality investment choices we offer—such as more funds that carry 4-star or 5-star ratings from Morningstar and those top-ranked by Lipper —the more successful we are. “In our group, deﬁnitions of success are as varied as the wide range of business customers we serve.They look to us to give them alternatives to cash ﬂow loans that help them achieve their objectives, and the ﬁnancial ﬂexibility they need to move from one phase to the next in the life cycle of their business. Success for us is providing this ﬂexibility but balancing the For us, great service is a given.Successful investment management is the result of our talented team delivering superior performance.” common sense of a lender with the innovative spirit of an entrepreneur.” Team members: 3,300 Customers: 32,000 Assets managed: $219 billion 17th largest U.S. mutual fund company (l to r): Mike Niedermeyer; Tom Hooley, Institutional Trust, Minneapolis, Minnesota; James Alexander, Institutional Brokerage and Sales, Chicago, Illinois Team members: 1,100 Customers: 1,200 Among top U.S. asset-based lenders (l to r): Peter Schwab; Eileen Quinn, Wells Fargo Foothill, Boston, Massachusetts; Paz Hernandez, Wells Fargo Foothill, Los Angeles, California 1 9 Dave Zuercher, International, Correspondent Banking, Insurance Years in ﬁnancial services: 36 Larry Chapman, Real Estate Years in ﬁnancial services: 32 Making the Complex Simple People First “Success means helping our domestic customers succeed wherever they do business in the world—to grow their earnings, seize global opportunities, and be their one-stop shop through our internet portal, Commercial Electronic Ofﬁce. We can open bank accounts for them in 66 countries, facilitate trade in 80 countries, and help reduce currency risk, payment processing risk, regulatory risk, and cultural risk.We succeed when We Make the Complex Simple®!” “For our team—even before real estate and credit—people come ﬁrst.That’s what creates success for our customers, our communities, Wells Fargo and our stockholders. We work with our partners across Wells Fargo to develop creative ﬁnancial solutions—such as ﬂexible acquisition, re-hab and construction loans—to help our customers build communities that provide people with housing, ofﬁces, factories, warehouses, schools, stores, shopping, recreation, lodging and jobs.” Team members: 5,000 Customers: 2,300 Includes Foreign Exchange,Treasury Management,Wells Fargo HSBC Trade Bank (l to r): Lillie Axelrod, Acordia, Atlanta,Georgia; Dave Zuercher; Sara Wardell-Smith, International Group, San Francisco, California Team members: 360 Customers: 485 One of U.S.’s leading lenders to developers and investors (l to r): Larry Chapman; Debora Welsh, Real Estate, Atlanta, Georgia; Juan Carlos Wallace, Real Estate, San Francisco, California 2 0 Cara Heiden and Mike Heid, Mortgage Years in ﬁnancial services: 25 and 26 Home and Heart “Our mission is homeownership. Our team members believe passionately in that mission.They live it every day.They believe and know that homeownership provides a rich, stable foundation upon which to achieve personal and ﬁnancial success. It’s the primary source of ﬁnancial net worth for most American households.They know that working together, we can help people reach their personal and ﬁnancial goals—through homeownership. We’re privileged to work in a business that helps people build wealth and provide a safe, secure environment for their families. Businesses measure success with numbers and so do we—but our most important measure is how we feel every time we know we’ve helped someone achieve the dream of homeownership.That’s how we picture success. It comes from the home and from the heart.” Team members: 28,000 Customers: 5.7 million #1 U.S. retail mortgage originator #2 U.S. mortgage servicer (l to r): Christiaan Lidstrom, Wells Fargo Home Mortgage, Des Moines, Iowa; Cara Heiden; Patrick Carey, Wells Fargo Home Mortgage, Fort Mill, South Carolina; Mike Heid 2 1 Tom Shippee, Wells Fargo Financial Years in ﬁnancial services: 32 Doreen Woo Ho, Consumer Credit, Corporate Trust Years in ﬁnancial services: 32 Serving and Selling Right Solutions “Our business model has changed profoundly the last few years.So has our picture of success.We’ve moved from offering small, unsecured loans to larger, secured loans, auto loans and ﬁrst mortgage products —and we’ve expanded credit card offerings to our best customers. To be more efﬁcient and give our customers faster service, we’ve freed up our store team members to spend most of their time serving and selling to customers—we now score all our loans electronically and collect all payments centrally. Our goal: common where possible, custom where it counts. These fundamental changes in our business model have driven unprecedented growth for Wells Fargo Financial—19 percent annual compound growth in receivables for the last six years—but they’ve also reduced our cost per loan which helps us lower interest rates for customers.” “Our success starts with attracting, keeping and growing the best team of professionals in ﬁnancial services.We’ve built a high- performing business model based on many partnerships.This allows us to deliver our products and services through our banking stores, mortgage stores,Wells Fargo Financial, wellsfargo.com, direct mail, telesales, Wells Fargo Phone Bank centers, brokers and correspondents. We listen to and educate customers.We guide them to the home equity and personal credit solutions that help them succeed ﬁnancially with smart management of their home asset and personal credit. Our innovative products and solutions sustain our lead in market share and earning more business from loyal customers helps grow it.” Team members: 21,000 Customers: 6.7 million Stores: 1,307 One of North America’s premier consumer ﬁnance companies (l to r): Stephanie D’Itri, Wells Fargo Financial Canada Corporation, Mississauga, Ontario; Susan Hack, Auto Finance, Chester, Pennsylvania; Tom Shippee Team members: 6,000 Households: 2.4 million #1 home equity lender, personal credit provider in U.S. (l to r): Doreen Woo Ho; Jody Bhagat, Consumer Credit, San Francisco, California; Tracy Schaefbauer, Home and Consumer Finance, Minneapolis, Minnesota 2 2 Promod Haque, Norwest Venture Partners Years in ﬁnancial services: 15 John Lindahl, Norwest Equity Partners Years in ﬁnancial services: 39 Dedicated Partners Resourceful, Approachable “We’ve partnered with entrepreneurs for 45 years to build great technology businesses.We pride ourselves on doing whatever it takes to help them build leading companies—facilitating customer and partner relationships for these companies, helping entrepreneurs evolve their business strategies, or working with CEOs to drive their recruiting processes. If our portfolio companies are successful, then we’re successful.What characterizes this success? Extreme dedication to these entrepreneurs. Deep operating experience. High integrity. And, a strong network of domestic and international relationships.” “Our success is built on strong partnerships. Strong partnerships with our portfolio companies. Strong partnerships with experienced management teams to acquire leading middle-market companies. To these relationships our investment professionals bring signiﬁcant resources to help management grow their business—including adequate capital to grow organically and by acquisition.We can supplement the company’s management team, provide operating expertise, and, when we exit the investment, guidance to maximize shareholder value. Our success, built on our 45-year history, requires skill, ability and integrity — the skill to recognize great companies, the ability to offer valuable expertise, the integrity to be resourceful, resilient and reliable partners.We succeed when, during our time as owners, the investors and our management partners create an even better company.” Early stage investments in information technology including semiconductor and components, systems, software, services and consumer/internet technologies. Invests in management buyouts, recapitalizations, and growth ﬁnancing for middle-market companies; one of oldest private equity ﬁrms in U.S. 2 3 Picturing the Next Stage of Success for Our Communities Our picture of success for our communities begins with our team members.They know their cities, towns and neighborhoods better than anyone else because they live and work there—so they’re the major voice in deciding how Wells Fargo responds to the distinct needs of their own community.We want them to care as much about their community’s quality of life as they do about their business’s bottom-line because the two are related. A report on our achievements in corporate citizenship for 2005 is available at www.wellsfargo.com/about/csr. St. Paul, Minnesota Once a polluted industrial site, these 200 acres now are home to indigenous plants and animals. Duane Ostlund, Business Banking Manager 2 4 Cleaning Up Polluted Land Eleven years ago, the Phalen Corridor was an environmental mess— 11 contaminated industrial sites covering 200 acres in a distressed community on the east side of St. Paul, Minnesota.Wells Fargo and 60 other public and private organizations came together to restore Phalen Corridor.The result: today it’s a thriving neighborhood with parks, wetlands, new homes, retailers and jobs. Wells Fargo team members Duane Ostlund (opposite page) and Judy Chapman serve on the Phalen Corridor Steering Committee. Thanks to their leadership, hundreds of hours volunteered by more than 30 other team members, and thousands of dollars in corporate contributions, the Phalen Corridor is now a revitalized community with 19 new businesses, 2,100 new jobs and 1,100 new homes. “This is a great example of tremendous results that can be achieved through a public, private and community partnership,” said Ostlund. As part of the extensive environmental cleanup,Wells Fargo helped restore Ames Lake wetlands, once ﬁlled-in with asphalt and used as a parking lot.Today Ames Lake is a habitat for hundreds of indigenous plants and animals. Other examples of Wells Fargo’s commitment to the environ- ment include: • A 10-point commitment to more effectively integrate environmental responsibility into our business practices. • A $1 billion lending, investment and other ﬁnancial commitment target for environmentally-beneﬁcial businesses. • Reducing in paper, energy and water consumption through services such as online statements and e-bills. • Promoting environmental responsibility for team members through an awareness campaign called “everyday actions.” 2 5 Since 1993, the Wells Fargo Housing Foundation has teamed up with hundreds of local housing non-profits such as Rebuilding Together and Habitat for Humanity to help make the dream of homeownership a reality for low-income families.The Foundation, through grants and the volunteerism of Wells Fargo team members, has helped build or renovate more than 1,900 homes. Who Do You Turn to When the Roof Leaks? The dream of living in a clean, warm, safe home can be a challenge for homeowners who are low-income, elderly or who have disabilities.Who do they turn to if the roof leaks or a handrail breaks? Over the past nine years, thanks in part to Wells Fargo’s partnership with Rebuilding Together, many seniors and families are now living independently and comfortably in their own homes. Wells Fargo has contributed over $650,000 and hundreds of team member volunteer hours to Rebuilding Together in 27 cities. Last April, a platoon of more than 20 Wells Fargo team members in Oklahoma City, Oklahoma, descended upon 10 houses on National Rebuilding Day for a hands-on renovation project.They helped install windows, ﬁx porches, paint, and add grab-bars and railings.“Everyone deserves to live in their own home,”said Wells Fargo team member Shelley Pruitt, board member for the local chapter of Rebuilding Together.“We’re fortunate to help improve the quality of life for residents in our community.” Oklahoma City, Oklahoma As the nation’s #1 retail mortgage originator, we work with non-proﬁts to help build and renovate homes for low-income families. (l to r): Wells Fargo Home Mortgage team members Chris Hunter, John Snodgrass and Shelley Pruitt with homeowner Clara Myers (second from left) 2 6 Engaging Parents in Education The Economics of Life Fifth grader Lucia (below), who attends Willard Intermediate School in Santa Ana, California, probably wouldn’t be reading the American classic “Tom Sawyer”if it weren’t for Wells Fargo team member Gabriela Cachua, Regional Banking, Orange County, California. She’s just one of the eight volunteer mentors who visited the school every week for a 10-week Reading Club. Two years ago,Wells Fargo connected with the Santa Ana Foundation to help out with Avanzando Familias Program, which engages parents in their child’s education to improve student academic performance.Mentors also teach students and their parents about budgeting, the importance of saving, bank accounts, and credit through Wells Fargo’s ﬁnancial literacy curriculum, Hands on Banking®. More than 5,000 team members have been trained to teach the Hands on Banking curriculum, available in both English and Spanish, in schools and community groups (handsonbanking.com). “It is never too early, or too late, to learn—whether it’s about enjoying a new book, or the basics of banking,”said Cachua. “Stay in school and you’ll be more successful on the job.” That’s been the message to eighth grade students for the past several years during Junior Achievement’s Job Shadow Day. Students interested in learning more about careers in banking visit a Wells Fargo store in Colorado Springs, Colorado to see a typical day in the banking world up close. More importantly, they learn about teamwork and how math, problem solving and communication skills are used each day on the job. Wells Fargo has partnered with Junior Achievement for more than 11 years and is one of the top three largest providers of volunteers to Junior Achievement in the nation. In 2005, over 1,500 team members volunteered in 1,630 classrooms nationwide to teach ﬁnancial literacy, leadership skills, and life lessons such as self conﬁdence and the importance of staying in school. First grader Sierra (below),Whittier Elementary School, participated in Junior Achievement workshops with Wells Fargo team member Doug Brewer last year. Santa Ana, California Seeking to increase student academic performance by encouraging parents to be active participants in their child's education. Wells Fargo team member and mentor Gabriela Cachua and student Colorado Springs, Colorado Educating and inspiring young people to become learners and leaders. 2 7 VolunteerWellsFargo! Why spend time helping others? Just ask any of the several thousand team members at Wells Fargo who volunteer in their communities.They’ll say that every smile, hug and “thank you” they receive makes it more than worthwhile. Every day, hundreds of team members across the country give their time, talent and resources to improve the quality of life in their communities. In 2005,Wells Fargo created a company-wide process to better manage and measure the company’s volunteer efforts. VolunteerWellsFargo! is an internet-based tool that helps connect team members with volunteer activities that match their interests and time.They use it to ﬁnd projects and recruit colleagues for beach clean ups, Habitat for Humanity house builds, fun runs, and tutoring projects, and to record their volunteer hours or board membership activities. Team members in Portland, Oregon use VolunteerWellsFargo! to organize groups of volunteers to prepare and serve hot meals to 90 homeless individuals at Transition Projects Inc., a non-proﬁt that Portland, Oregon Helping satisfy the basic needs of the homeless as they transition to housing. provides shelter and helps the homeless get back on their feet. Team members (below, from left) Kellie Pearse, Mary Hills, Denise Sandefur, Robin Thomas, Fe Dolor, Charlie Jones, Michelle Troﬁtter and Karen Schmidt are among over 30 team members who take turns volunteering every month to plan, provide, prepare and serve meals at the shelter. So far, over 20 percent of our team members have logged onto the VolunteerWellsFargo! website and over nine percent have recorded their hours.“This new tool will give us a better understanding of how we make our communities even better places to live and work,”said Tim Schreck, community support manager.“It will also show us for the ﬁrst time the incredible quantity and quality of all our volunteer efforts, which we believe are just as important if not more important than the $95 million our company contributed to non-proﬁts this year.We can now track our progress toward becoming one of the top contributors in team member volunteerism in all of corporate America.” 2 8 3 9 5 9 2 8 3 8 6 6 $ 03 02 01 Wells Fargo Contributions – 2005 (millions, cash basis) 04 05 Hurricane Katrina: The “Next Stage” Hurricane Katrina caused unprecedented devastation in the Gulf States. Our response to help our affected customers also was unprecedented: • We allowed them to defer mortgage payments for an initial 90 days, through November 2005. • We then extended that mortgage deferral period another 90 days, through February 2006. • During those deferral periods, we suspended all late fees, negative credit reports and collection calls for them. • Using dedicated toll-free phone numbers, we helped affected customers with personal ﬁnancial counseling to determine the most reasonable payment solution after the deferral period ended. Corporate America’s 10 Largest Givers–2004 (dollars in millions) Johnson & Johnson 1. Wal-Mart Stores 2. 3. Altria Group 4. Citigroup 5. Ford Motor 6. Bank of America 7. Target 8. Exxon Mobil 9. Wells Fargo 10. Wachovia Source: BusinessWeek 11/28/05 $188.0 121.8 113.4 111.3 109.8 108.0 107.8 106.5 93.0 81.7 Wells Fargo Receives Highest Possible Rating for Community Reinvestment Wells Fargo Bank, N.A. received an “Outstanding”rating—the highest rating possible, earned by less than one of every ﬁve national banks —in its most recent Community Reinvestment Act examination by the Ofﬁce of the Comptroller of the Currency (OCC).The Bank met or exceeded community needs in areas such as affordable housing, ﬁnancial education and small business lending. For Wells Fargo, community reinvestment is not just about meeting the requirements of a law, it’s about helping our communities grow and prosper. It’s just good business.We’d do it even if there was no CRA! Here are just some of the more than 15,000 non-proﬁts we supported in 2005: • Residents of Alabama, Louisiana and Mississippi could make Arts free withdrawals from any Wells Fargo ATM, nationwide through year-end 2005, whether or not they had a Wells Fargo account. • We increased the daily spending limit for our ATM and Check Card customers in affected areas of those states. • Our affected small business customers could get emergency increases in their credit lines, bridge loans, term loans, credit protection, deferred loan payments and fee waivers. • We deferred credit card payments for affected customers through year-end 2005, waived over-limit, late, or non-sufﬁcient funds fees, and suspended collection calls and negative credit bureau reporting. • Our Company and team members contributed a total of $1.5 million to the American Red Cross and United Way Hurricane Katrina Relief Funds. Santa Rosa, California – $3.75 million in ﬁnancial support over 10 years. Wells Fargo provided a grant to the Luther Burbank Center for the Arts to help renovate and operate the 140,000 square foot art and performance venue. Greg Morgan, community banking president, serves on the board. Des Moines, Iowa – $1.2 million in ﬁnancial support and 56 prints by American artists to the Des Moines Art Center.The project is one reason Wells Fargo was recognized as one of the “Ten Best Companies Supporting the Arts in America”by the New York-based Business Committee for the Arts. Billings, Montana – 33 years as lead sponsor of Symphony in the Park, a free cultural event for the community showcasing the Billings Symphony and other local musicians. Last year 55 team members helped staff the event. Lincoln, Nebraska – For the second year in a row, Wells Fargo sponsored Celebrate Lincoln, an outdoor cultural event featuring live music, dancing, arts and crafts, and food from around the globe. Over 40 Wells Fargo team members volunteered at the event. 2 9 Community Development Environment Anchorage, Alaska – $100,000 grant for affordable housing through the Wells Fargo Housing Foundation’s seventh annual Focus Communities Initiative.Wells Fargo team members raised an additional $1,400 for Cook Inlet Housing Authority. Oakland, California – $6 million investment in the East Bay Asian Local Development Corporation for Preservation Park, a renovated Victorian-style business park that provides affordable ofﬁce space to non-proﬁts facing eviction. Pueblo, Colorado – 35 home improvement projects. Wells Fargo partnered with NeighborWorks, a non-proﬁt that provides affordable housing, education and down payment assistance.Team member Brad Ahl led a group of co-workers to help paint the trims and garages of 35 homes during their annual Operation Paintbrush event. Mission, South Dakota – $125,000 to help families of the Rosebud Sioux Tribe.Wells Fargo team members are working with Habitat for Humanity to build ﬁve homes on the Rosebud Indian Reservation. Team member Samantha Keller used the company’s new online tool, VolunteerWellsFargo!, to recruit over 75 volunteers. Austin,Texas – $20,000 so far to help 10 families buy ﬁrst homes. Wells Fargo supports the Austin Area Urban League’s new down payment assistance program. Low-income individuals who complete a free, monthly workshop receive $2,000 in down payment assistance. Brigham City, Utah – $17,500 grant and eight new homes. Wells Fargo provided a grant to the Neighborhood Nonproﬁt Housing Agency for affordable housing.Wells Fargo team members volunteered every Saturday for seven weeks to help build homes. Richmond,Virginia – 700 African American adults attended a free workshop on practical approaches to ﬁnancial management, including homeownership and saving for retirement.This was one of 23 wealth-building seminars held around the country in 2005. Education Phoenix, Arizona – Every week, two dozen Wells Fargo team members visit students at Lowell Elementary School as part of the Big Brothers and Big Sisters “Lunch Buddy”mentoring program.Team members also raised $15,000 to renovate the school’s playground. Fort Wayne, Indiana – For the tenth year in a row, Wells Fargo sponsored the YMCA Celebration of Youth event. Every year eight students receive a $700 college scholarship from Wells Fargo in honor of their community involvement activities. Las Vegas, Nevada – $50,000 to teachers in 17 schools. Wells Fargo’s “Grant a Wish for Your School”program awarded up to $3,000 each to teachers across the state for special classroom projects focused on ﬁnancial literacy, math, technology and careers. Chester, Pennsylvania – 720 backpacks and $5,000 grant. Team members from Wells Fargo Auto Finance partnered with the Junior League to kick off the school year in style.Team members visited Columbus Elementary School and gave each student a backpack ﬁlled with school supplies. Milwaukee,Wisconsin – A decade of support. Wells Fargo worked with the Greater Milwaukee Committee and other business leaders to create the School Partnership Program.The program helps prepare young people for their future by teaching them healthy ﬁnancial habits and other life-skills. During the past 10 years, over 100 team members have volunteered. 3 0 San Francisco, California – Energy consumption reduced by 20 percent at Wells Fargo’s buildings throughout California since 2001.Wells Fargo modernized the energy management technology at its headquarters building and earned the Energy Star Award from the Environmental Protection Agency for being among the top 10 percent of the nation’s most energy-efﬁcient buildings. Santa Ana, California – For the second year, Wells Fargo participated in the California Coastal Commission’s Coastal Cleanup Day.Thirty- two team members helped clean up two miles of coastline, picking up over 50 bags of trash and debris. Beaverton, Oregon – 15,000+ red wiggler worms are helping reduce and recycle waste at Wells Fargo’s William Barnhart Center (operations and customer service).The “worm ranch”residents eat up to 20 pounds of fruits, vegetables, coffee grounds and other leftovers every day from the cafeteria, and their castings are recycled for fertilizer. Human Services Los Angeles, California – $20,000 grant and seven school makeovers. 240 Wells Fargo team members helped celebrate Mayor Villaraigosa’s 100th day in ofﬁce by lending a hand during a “Day of Service.” Volunteers helped seven local schools get a much-needed face lift by planting ﬂowers, cleaning up grafﬁti and painting classrooms. Boise, Idaho – 114 computers for K-12 students thanks in part to a donation from Wells Fargo to Computers for Kids, a non-proﬁt that upgrades computers for children in need. Fourteen Wells Fargo team members volunteered to deliver the computers. Minneapolis, Minnesota – $50,000 to help the developmentally disabled become more independent. Team member Gary Johnson won the Wells Fargo Volunteer Service Award on behalf of Reach for Resources, where he volunteers and serves on the board. He is one of 164 team members awarded $321,000 in grants in 2005 for their designated non-proﬁts. McKinney,Texas – 2,000 hurricane evacuees sheltered. When Jack Haye of Wholesale Banking learned that his community would be providing shelter to Hurricane Katrina evacuees, he stepped up to the plate. Haye managed a shelter and helped coordinate hundreds of volunteers to collect and distribute donations and provide disaster relief services. Seattle,Washington – Two years of board participation and $25,000 in ﬁnancial support. Wells Fargo donated a 9,000 square foot former banking store to Domestic Abuse Women’s Network for its ofﬁce space.Team member Jennifer Politakis serves as a board member. Casper,Wyoming – $33,500 raised for United Way. Wells Fargo regional president Michael Matthews rallied team members to donate funds during the annual Community Support Campaign. Each donation earned them a two-foot section of duct tape which was later used to tape community bank president, Tom Kugler, to a wall. Newfoundland, Canada – 1 new laptop. When Wells Fargo Financial Canada team member Valerie Clarke heard about a bedridden young man with Crohn’s disease whose computer broke down, she teamed up with Lion’s Club to give him a new laptop. Board of Directors J.A. Blanchard III 1, 2, 4 Chairman ADC Telecommunications Eden Prairie, Minnesota (Communications equipment, services) Lloyd H. Dean 1, 3 President, CEO Catholic Healthcare West San Francisco, California (Health care) Susan E. Engel 2, 3, 5 Chairwoman, CEO Lenox Group Inc. Eden Prairie, Minnesota (Specialty retailer) Enrique Hernandez, Jr. 1, 3 Chairman, CEO Inter-Con Security Systems, Inc. Pasadena, California (Security services) Robert L. Joss 2, 3 Philip H. Knight Professor and Dean Stanford U. Graduate School of Business Palo Alto, California (Higher education) Reatha Clark King 1, 3 Retired President, Board Chair General Mills Foundation Minneapolis, Minnesota (Corporate foundation) Donald B. Rice 4, 5 Chairman, President, CEO Agensys, Inc. Santa Monica, California (Biotechnology) Richard M. Kovacevich Chairman, CEO Wells Fargo & Company San Francisco, California Richard D. McCormick 3 Chairman Emeritus US WEST, Inc. Denver, Colorado (Communications) Cynthia H. Milligan 1, 4 Dean College of Business Administration University of Nebraska – Lincoln (Higher education) Philip J. Quigley 1, 2, 4 Retired Chairman, President, CEO Paciﬁc Telesis Group San Francisco, California (Telecommunications) Judith M. Runstad 1, 3 Of Counsel Foster Pepper & Shefelman PLLC Seattle, Washington (Law ﬁrm) Stephen W. Sanger 3, 5 Chairman, CEO General Mills, Inc. Minneapolis, Minnesota (Packaged foods) Susan G. Swenson 1, 2, 4 Former COO T-Mobile USA, Inc. Bellevue, Washington (Wireless communications) Michael W. Wright 2, 4, 5 Retired Chairman, CEO SUPERVALU INC. Eden Prairie, Minnesota (Food distribution, retailing) Standing Committees: 1. Audit and Examination; 2. Credit; 3. Finance; 4. Governance and Nominating; 5. Human Resources Executive Ofﬁcers and Corporate Staff Richard M. Kovacevich, Chairman, CEO * Paul R. Ackerman, Treasurer David J. Munio, Chief Credit Ofﬁcer * John G. Stumpf, President, COO * Senior Executive Vice Presidents Howard I. Atkins, Chief Financial Ofﬁcer * David A. Hoyt, Wholesale Banking * Mark C. Oman, Home and Consumer Finance * * “Executive ofﬁcers” according to Securities and Exchange Commission rules Patricia R. Callahan, Compliance and Risk Management * Bruce E. Helsel, Corporate Development Lawrence P. Haeg, Corporate Communications Ellen Haude, Investment Portfolio Laurel A. Holschuh, Corporate Secretary Richard D. Levy, Controller * Kevin McCabe, Chief Auditor Avid Modjtabai, Human Resources * Michael J. Loughlin, Deputy Chief Credit Ofﬁcer Victor K. Nichols, Technology Eric D. Shand, Chief Loan Examiner Diana L. Starcher, Customer Service, Sales, Operations Robert S. Strickland, Investor Relations James M. Strother, General Counsel, Government Relations * Carrie L.Tolstedt, Regional Banking * 3 1 Senior Business Ofﬁcers COMMUNITY BANKING Regional Banking Carrie L.Tolstedt Regional Presidents James O. Prunty, Great Lakes and Plains Debra J. Paterson, Metro Minnesota Norbert D. Harrington, Greater Minnesota J. Lanier Little, Illinois, Michigan, Wisconsin Carl A. Miller, Jr., Indiana, Ohio Daniel P. Murphy, South Dakota Peter J. Fullerton, North Dakota Paul W.“Chip” Carlisle, Texas George W. Cone, Heart of Texas John T. Gavin, Dallas-Fort Worth Glenn V. Godkin, Houston Don C. Kendrick, Central Texas Kenneth A.Telg, West Texas Private Client Services/ Internet Services Clyde W. Ostler Jay Welker, Private Client Services Regional Managing Directors Anne D. Copeland, Northern California, Central California, Nevada Joe W. DeFur, Los Angeles Metro James Cimino, Southern California, Orange County, Arizona Jeffrey Grubb, Washington, Oregon, Idaho, Alaska David J. Kasper, Colorado, Utah, Montana, Wyoming Russell A. Labrasca, Texas, New Mexico David J. Pittman, Illinois, Iowa, Nebraska Timothy N.Traudt, Minnesota, North Dakota, South Dakota, Wisconsin, Indiana, Ohio, Michigan Tracey B. Warson, San Francisco Bay Area Thomas W. Honig, Colorado, Montana, Lance P. Fox, Credit Administration Utah, Wyoming Joy N. Ott, Montana Robert A. Hatch, Utah Matthew J. Lynett, Metro Denver Donald R. Sall, Greater Colorado Michael J. Matthews, Wyoming H. Lynn Horak, Iowa, Nebraska Kirk L. Kellner, Nebraska J. Scott Johnson, Iowa Laura A. Schulte, Western Banking Michael F. Billeci, Greater San Francisco Bay Area Nathan E. Christian, Southern California, Border Banking William J. Dewhurst, Central California Felix S. Fernandez, Northern California Shelley Freeman, Los Angeles Metro Alan V. Johnson, Oregon J. Pat McMurray, Idaho Lisa J. Stevens, San Francisco Metro Richard Strutz, Alaska Robert D.Worth, California Business Banking Patrick G.Yalung, Washington State Kim M.Young, Orange County Gerrit van Huisstede, Arizona, Nevada, New Mexico Kirk V. Clausen, Nevada Gregory A. Winegardner, New Mexico Mergers and Acquisitions Jon R. Campbell Business Banking Support Group Timothy J. Coughlon Marketing Sylvia L. Reynolds Diversiﬁed Products Michael R. James Marc L. Bernstein, Business Direct Lending Louis M. Cosso, Auto Finance Jerry E. Gray, SBA Lending Michael T. Borchert, Payroll Services Rebecca Macieira-Kaufmann, Small Business Segment Kevin A. Rhein, Wells Fargo Card Services Daniel I. Ayala, Global Remittance Services Edward M. Kadletz, Debit Card Debra B. Rossi, Payment Solutions Jon A. Veenis, Education Finance Services HOME AND CONSUMER FINANCE Mark C. Oman Wells Fargo Home Mortgage Michael J. Heid, Division President, Capital Markets, Finance, Administration Cara K. Heiden, Division President, National Consumer Lending, Institutional Lending Susan A. Davis, Centralized Retail/ Retail Administration Michael Lepore, Institutional Lending Consumer Credit Doreen Woo Ho, President Brian J. Bartlett, Corporate Trust John W. Barton, Regional Banking/Personal Credit Management Scott Gable, Personal Credit Management Meheriar M. Hasan, Direct to Consumer Kathleen L. Vaughan, Equity Direct, Institutional Lending 3 2 Wells Fargo Financial, Inc. International and Insurance Services Thomas P. Shippee, CEO, President David J. Zuercher Greg M. Janasko, Commercial Business Peter J. Wissinger, President, CEO, Acordia, Inc. David R. Kvamme, Consumer Business Michael E. Connealy, Rural Community Gary D. Lorenz, Auto Business Jaime Marti, Latin American Auto Insurance Services Neal Aton, Wells Fargo Insurance Oriol Segarra, Latin American Consumer Ronald A. Caton, Global Correspondent Banking and U.S. Hispanic WHOLESALE BANKING David A. Hoyt Commercial Banking Iris S. Chan John C. Adams, Northern California JoAnn N. Bertges, Western Robert A. Chereck, Texas Albert F. (Rick) Ehrke, Southern California Mark D. Howell, Intermountain/Southwest Paul D. Kalsbeek, Southeast Richard J. Kerbis, Northeast Peter P. Connolly, Foreign Exchange/ International Financial Services Sanjiv S. Sanghvi, Wells Fargo HSBC Trade Bank Asset-Based Lending John F. Nickoll Peter E. Schwab, Wells Fargo Foothill Henry K. Jordan, Wells Fargo Foothill Thomas Pizzo, Wells Fargo Century Martin J. McKinley, Wells Fargo Business Credit Jeffrey T. Nikora, Alternative Investment Management Eastdil Secured, LLC Benjamin V. Lambert, Chairman Edmund O. Lelo, Greater Los Angeles Roy H. March, CEO Perry G. Pelos, Midwest John V. Rindlaub, Paciﬁc Northwest D. Michael Van Konynenburg, President W. Jay Borzi, Managing Director Asset Management Michael J. Niedermeyer Robert W. Bissell, Wells Capital Management James W. Paulsen, Wells Capital Management John S. McCune, Institutional Brokerage Laurie B. Nordquist, Institutional Trust Karla M. Rabusch, Wells Fargo Funds Wholesale Services Stephen M. Ellis Norwest Equity Partners John E. Lindahl, Managing Partner Norwest Venture Partners Promod Haque, Managing Partner Credit Administration Thomas J. Davis, Real Estate David J. Weber, Commercial/Corporate Specialized Financial Services Timothy J. Sloan J. Edward Blakey, Commercial Mortgage David B. Marks, Corporate Banking, Shareowner Services John P. Hullar, Wells Fargo Securities Jay Kornmayer, Gaming Mark L. Myers, Real Estate Merchant Banking, Homebuilder Finance J. Michael Johnson, Financial Sponsors, Leveraged, Media and Mezzanine Finance, Distribution John M. McQueen, Wells Fargo Equipment Finance John R. Shrewsberry, Securities Investment Real Estate A. Larry Chapman Charles H. Fedalen, Jr., Southern California/Southwest Shirley O. Grifﬁn, Real Estate Portfolio Services Christopher J. Jordan, Mid-Atlantic/ New England Robin W. Michel, Northern California/Northwest James H. Muir, Eastern/Midwest Stephen P. Prinz, Central/Texas Financial Review 34 Overview 38 Critical Accounting Policies Earnings Performance 41 41 Net Interest Income 44 Noninterest Income 45 Noninterest Expense 45 Income Tax Expense 45 Operating Segment Results 46 46 Balance Sheet Analysis Securities Available for Sale (table on page 71) Loan Portfolio (table on page 73) 46 46 Deposits 47 Off-Balance Sheet Arrangements and Aggregate Contractual Obligations 47 Off-Balance Sheet Arrangements, Variable Interest Entities, Guarantees and Other Commitments 48 Contractual Obligations 48 Transactions with Related Parties Risk Management 49 49 Credit Risk Management Process 49 Nonaccrual Loans and Other Assets Loans 90 Days or More Past Due 50 and Still Accruing Allowance for Credit Losses (table on page 75) 51 52 Asset/Liability and Market Risk Management Interest Rate Risk 52 52 Mortgage Banking Interest Rate Risk 54 Market Risk – Trading Activities 54 Market Risk – Equity Markets Liquidity and Funding 54 56 Capital Management 57 Comparison of 2004 with 2003 Controls and Procedures 58 Disclosure Controls and Procedures 58 Internal Control over Financial Reporting 58 Management’s Report on Internal Control over Financial Reporting 59 Report of Independent Registered Public Accounting Firm Financial Statements 60 Consolidated Statement of Income 61 Consolidated Balance Sheet 62 Consolidated Statement of Changes in Stockholders’ Equity and Comprehensive Income 63 Consolidated Statement of Cash Flows 64 Notes to Financial Statements 112 Report of Independent Registered Public Accounting Firm 113 Quarterly Financial Data 115 Glossary 33 This Annual Report, including the Financial Review and the Financial Statements and related Notes, has forward-looking statements, which may include forecasts of our ﬁnancial results and condition, expectations for our operations and business, and our assumptions for those forecasts and expectations. Do not unduly rely on forward-looking statements. Actual results might differ signiﬁcantly from our forecasts and expectations due to several factors. Some of these factors are described in the Financial Review and in the Financial Statements and related Notes. For a discussion of other factors, refer to the “Risk Factors” and “Regulation and Supervision” sections of our Annual Report on Form 10-K for the year ended December 31, 2005, ﬁled with the Securities and Exchange Commission (SEC) and available on the SEC’s website at www.sec.gov. Financial Review Overview Wells Fargo & Company is a $482 billion diversiﬁed ﬁnancial services company providing banking, insurance, investments, mortgage banking and consumer ﬁnance through banking stores, the internet and other distribution channels to con- sumers, businesses and institutions in all 50 states of the U.S. and in other countries. We ranked ﬁfth in assets and fourth in market value of our common stock among U.S. bank holding companies at December 31, 2005. When we refer to “the Company,” “we,” “our” and “us” in this Report, we mean Wells Fargo & Company and Subsidiaries (consolidated). When we refer to “the Parent,” we mean Wells Fargo & Company. We had another exceptional year in 2005, with record diluted earnings per share of $4.50, record net income of $7.7 billion and solid market share growth across our more than 80 businesses. Our earnings growth from a year ago was broad based, with nearly every consumer and commercial business line achieving double-digit proﬁt growth, including regional banking, private client services, corporate trust, business direct, asset-based lending, student lending, consumer credit, commercial real estate and international trade services. Both net interest income and noninterest income for 2005 grew solidly from last year and virtually all of our fee-based products had double-digit revenue growth. We took signiﬁcant actions to reposition our balance sheet in 2005 designed to improve yields on earning assets, including the sale of $48 billion of our lowest-yielding adjustable rate mortgages (ARMs), resulting in $119 million of sales-related losses, and the sale of $17 billion of debt securities, including low-yielding ﬁxed-income securities, resulting in $120 million of losses. Our growth in earnings per share was driven by revenue growth, operating leverage (revenue growth in excess of expense growth) and credit quality, which remained solid despite the following credit-related events: • $171 million of net charge-offs from incremental consumer bankruptcy ﬁlings nationwide due to a change in bankruptcy law in October 2005; • $163 million ﬁrst quarter 2005 initial implementation of conforming to more stringent Federal Financial Institutions Examination Council (FFIEC) charge-off rules at Wells Fargo Financial; and • $100 million provision for credit losses for our assessment of the effect of Hurricane Katrina. 34 Our primary sources of earnings are driven by lending and deposit taking activities, which generate net interest income, and providing ﬁnancial services that generate fee income. Revenue grew 10% from 2004. In addition to double-digit growth in earnings per share, we also had double-digit growth in average loans. We have been achieving these results not just for one year, but for the past ﬁve, 10, 15 and 20 years. Our total shareholder return the past ﬁve years was 10 times that of the S&P 500®, and almost double the S&P 500 including the past 10, 15 and 20 years. These periods included almost every economic cycle and economic condition a ﬁnancial institution can experience, including high and low interest rates, high and low unemployment, bubbles and recessions and all types of yield curves – steep, ﬂat and inverted. For us to achieve double-digit growth through different economic cycles, our primary strategy, consistent for 20 years, is to satisfy all our customers’ ﬁnancial needs, help them succeed ﬁnancially and, through cross-selling, gain market share, wallet share and earn 100% of their business. We have stated in the past that to consistently grow over the long term, successful companies must invest in their core businesses and in maintaining strong balance sheets. We continued to make investments in 2005 by opening 92 banking stores, seven commercial banking ofﬁces, 47 mortgage stores and 20 consumer ﬁnance stores. We continued to be #1 nationally in retail mortgage originations, home equity lending, small business lending, agricultural lending, consumer internet banking, and providing ﬁnancial services to middle-market companies in the western U.S. LONG-TERM PERFORMANCE – TOTAL COMPOUND ANNUAL STOCKHOLDER RETURN (Including reinvestment of dividends) 21 21 11 12 17 9 5% .5 5 years (percent) 10 Wells Fargo Common Stock 15 20 S&P 500 25 20 15 10 5 0 -5 Our solid ﬁnancial performance enables us to be one of the top givers to non-proﬁts among all U.S. companies. We continued to have the only “Aaa” rated bank in the U.S., the highest possible credit rating issued by Moody’s Investors Service. Our vision is to satisfy all the ﬁnancial needs of our customers, 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 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. At year-end 2005, our average cross-sell set new records for the Company – our average retail banking household now has 4.8 products with us, up from 4.6 a year ago and our average Wholesale Banking customer now has a record 5.7 products. Our goal is eight products per customer, which is currently half of our estimate of potential demand. Our core products grew this year: • Average loans grew by 10%; • Average retail core deposits grew by 10% (average core deposits grew by 9%); and • Assets managed and administered were up 11%. We believe it is important to maintain a well controlled environment as we continue to grow our businesses. We manage our credit risk by maintaining prudent credit policies for underwriting with effective procedures for monitoring and review. We have a well diversiﬁed loan portfolio, measured by industry, geography and product type. We manage the interest rate and market risks inherent in our asset and liability balances within prudent ranges, while ensuring adequate liquidity and funding. Our stockholder value has increased over time due to customer satisfaction, strong ﬁnancial results, investment in our businesses and the prudent way we attempt to manage our business risks. Our ﬁnancial results included the following: Net income in 2005 increased 9% to $7.7 billion from $7.0 billion in 2004. Diluted earnings per common share increased 10% to $4.50 in 2005 from $4.09 in 2004. Return on average total assets was 1.72% and return on average common equity was 19.57% in 2005, and 1.71% and 19.56%, respectively, in 2004. Net interest income on a taxable-equivalent basis was $18.6 billion in 2005, compared with $17.3 billion a year ago, reﬂecting solid loan growth (other than ARMs) and a relatively ﬂat net interest margin. Average earning assets grew 8% from a year ago, or 15% excluding 1-4 family ﬁrst mortgages. Our net interest margin was 4.86% for 2005, compared with 4.89% in 2004. Given the prospect of higher short-term interest rates and a ﬂatter yield curve, beginning in second quarter 2004, as part of our asset/liability management strategy, we sold the lowest-yielding ARMs on our balance sheet, replacing some of these loans with higher-yielding ARMs. At the end of 2005, new ARMs being held for investment within real estate 1-4 family mortgage loans had yields more than 1% higher than the average yield on the ARMs sold since second quarter 2004. Noninterest income increased 12% to $14.4 billion in 2005 from $12.9 billion in 2004. Double-digit growth in noninterest income was driven by growth across our busi- nesses, with particular strength in trust, investment and IRA fees, card fees, loan fees, mortgage banking income and gains on equity investments. Revenue, the sum of net interest income and noninterest income, increased 10% to a record $32.9 billion in 2005 from $30.1 billion in 2004 despite balance sheet reposition- ing actions, including losses from the sales of low-yielding ARMs and debt securities. For the year, Wells Fargo Home Mortgage (Home Mortgage) revenue increased $455 million, or 10%, from $4.4 billion in 2004 to $4.9 billion in 2005. Operating leverage improved during 2005 with revenue growing 10% and noninterest expense up only 8%. Noninterest expense was $19.0 billion in 2005, up 8% from $17.6 billion in 2004, primarily due to increased mortgage production and continued investments in new stores and additional sales-related team members. Noninterest expense also included a $117 million expense to adjust the estimated lives for certain depreciable assets, primarily building improvements, $62 million of airline lease write-downs, $56 million of integration expense and $25 million for the adoption of FIN 47. We began expensing stock options, as required, on January 1, 2006. Taking into account our February 2006 option grant, we anticipate that total stock option expense will reduce earnings by approximately $.06 per share for 2006. During 2005, net charge-offs were $2.28 billion, or .77% of average total loans, compared with $1.67 billion, or .62%, during 2004. Credit losses for 2005 included $171 million of incremental fourth quarter bankruptcy losses and increased losses of $163 million for ﬁrst quarter 2005 initial implementation of conforming to more stringent FFIEC charge-off timing rules at Wells Fargo Financial. The provision for credit losses was $2.38 billion in 2005, up $666 million from $1.72 billion in 2004. The 2005 provision for credit losses also included $100 million for estimated credit losses related to Hurricane Katrina. The allowance for credit losses, which consists of the allowance for loan losses and the reserve for unfunded credit commitments, was $4.06 billion, or 1.31% of total loans, at December 31, 2005, compared with $3.95 billion, or 1.37%, at December 31, 2004. At December 31, 2005, total nonaccrual loans were $1.34 billion, or .43% of total loans, down from $1.36 billion, or .47%, at December 31, 2004. Foreclosed assets were $191 million at December 31, 2005, compared with $212 million at December 31, 2004. 35 1.72% 1.71% 1.64% On March 30, 2005, the FASB issued Interpretation No. 47, The ratio of stockholders’ equity to total assets was 8.44% at December 31, 2005, compared with 8.85% at December 31, 2004. Our total risk-based capital (RBC) ratio at December 31, 2005, was 11.64% and our Tier 1 RBC ratio was 8.26%, exceeding the minimum regulatory guidelines of 8% and 4%, respectively, for bank holding companies. Our RBC ratios at December 31, 2004, were 12.07% and 8.41%, respectively. Our Tier 1 leverage ratios were 6.99% and 7.08% at December 31, 2005 and 2004, respectively, exceeding the minimum regulatory guideline of 3% for bank holding companies. Table 1: Ratios and Per Common Share Data Year ended December 31 , 2003 2004 2005 PROFITABILITY RATIOS Net income to average total assets (ROA) Net income applicable to common stock to average common stockholders’ equity (ROE) Net income to average stockholders’ equity EFFICIENCY RATIO (1) CAPITAL RATIOS At year end: Stockholders’ equity to assets Risk-based capital (2) Tier 1 capital Total capital Tier 1 leverage (2) Average balances: 19.57 19.59 57.7 19.56 19.57 19.36 19.34 58.5 60.6 8.44 8.85 8.89 8.26 11.64 6.99 8.41 12.07 7.08 8.42 12.21 6.93 Stockholders’ equity to assets 8.78 8.73 8.49 PER COMMON SHARE DATA Dividend payout (3) Book value Market price (4) High Low Year end 44.0 $24.25 44.8 $22.36 40.7 $20.31 $64.70 57.62 62.83 $64.04 54.32 62.15 $59.18 43.27 58.89 (1) The efﬁciency ratio is noninterest expense divided by total revenue (net interest income and noninterest income). (2) See Note 25 (Regulatory and Agency Capital Requirements) to Financial Statements for additional information. (3) Dividends declared per common share as a percentage of earnings per common share. (4) Based on daily prices reported on the New York Stock Exchange Composite Transaction Reporting System. Current Accounting Developments On December 16, 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (FAS 123R), which replaced FAS 123, Accounting for Stock- Based Compensation, and superceded Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. We adopted FAS 123R on January 1, 2006, using the “modiﬁed prospective” transition method. The scope of FAS 123R includes a wide range of stock-based compensation arrangements including stock options, restricted 36 stock plans, performance-based awards, stock appreciation rights, and employee stock purchase plans. FAS 123R requires that we measure the cost of employee services received in exchange for an award of equity instruments based on the fair value of the award on the grant date. That cost must be recognized in the income statement over the vesting period of the award. Under the “modiﬁed prospective” transition method, awards that are granted, modiﬁed or settled begin- ning at the date of adoption will be measured and accounted for in accordance with FAS 123R. In addition, expense must be recognized in the income statement for unvested awards that were granted prior to the date of adoption. The expense will be based on the fair value determined at the grant date. Taking into account our February 2006 option grant, we anticipate that total stock option expense will reduce 2006 earnings by approximately $.06 per share. Accounting for Conditional Asset Retirement Obligations – An Interpretation of FASB Statement No. 143 (FIN 47). FIN 47 was issued to address diverse accounting practices that developed with respect to the timing of liability recognition for legal obligations associated with the retirement of tangible long-lived assets, such as building and leasehold improvements, when the timing and/or method of settlement of the obligations are conditional on a future event. FIN 47 requires companies to recognize a liability for the fair value of a conditional asset retirement obligation when incurred if the liability’s fair value can be reasonably estimated. We adopted FIN 47 in 2005 and recorded a $25 million charge to noninterest expense. We continuously monitor emerging accounting issues, including proposed standards issued by the FASB, for any impact on our ﬁnancial statements. We are currently aware of a proposed FASB Staff Position (FSP) related to the accounting for leveraged lease transactions for which there have been cash ﬂow estimate changes based on when income tax beneﬁts are recognized. Certain leveraged lease transac- tions have been challenged by the Internal Revenue Service (IRS). While we have not made investments in a broad class of transactions that the IRS commonly refers to as “Lease-In, Lease-Out” (LILO) transactions, we have previously invested in certain leveraged lease transactions that the IRS labels as “Sale-In, Lease-Out” (SILO) transactions. We have paid the IRS the income tax associated with our SILO transactions. However, we are continuing to vigorously defend our initial ﬁling position as to the timing of the tax beneﬁts associated with these transactions. If the draft FSP had been effective at December 31, 2005, we would have been required to record a pre-tax charge of approximately $125 million as a cumula- tive effect of change in accounting principle. However, subse- quent deliberations by the FASB could signiﬁcantly change the draft FSP, which, in turn, could affect our estimate and the method of adoption. We will continue to monitor the FASB’s deliberations regarding this proposal. On August 11, 2005, the FASB issued for public comment an Exposure Draft that would amend FAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. This Exposure Draft, Accounting for Servicing of Financial Assets – An Amendment of FASB Statement No. 140, would require that all separately recognized servicing rights be initially measured at fair value, if practicable. For each class of separately recognized servicing assets and liabilities, this proposed standard would permit an entity to choose from two subsequent measurement methods. Specifically, an entity could amortize servicing assets and liabilities in proportion to and over the period of estimated net servicing income or servicing loss (effectively the existing requirement in FAS 140) or an entity could report servicing assets or liabilities at fair value at each reporting date with any changes reported currently in operations. We expect this guidance to be ﬁnalized and issued in early 2006. Based on the guidance in the current Exposure Draft, it is likely that we will adopt the fair value alternative upon issuance of the standard. We will continue to monitor this emerging guidance in order to ﬁnalize our decision and determine the impact on our ﬁnancial statements. Table 2: Six-Year Summary of Selected Financial Data (in millions, except per share amounts) INCOME STATEMENT Net interest income Noninterest income Revenue Provision for credit losses Noninterest expense Before effect of change in accounting principle (1) Net income Earnings per common share Diluted earnings per common share After effect of change in accounting principle Net income Earnings per common share Diluted earnings per common share Dividends declared per common share BALANCE SHEET (at year end) Securities available for sale Loans Allowance for loan losses Goodwill Assets Core deposits (2) Long-term debt Guaranteed preferred beneﬁcial interests in Company’s subordinated debentures (3) Stockholders’ equity 2005 2004 2003 2002 2001 2000 % Change 2005/ 2004 Five-year compound growth rate $ 18,504 14,445 32,949 2,383 19,018 $ 17,150 12,909 30,059 1,717 17,573 $ 16,007 12,382 28,389 1,722 17,190 $ 14,482 10,767 25,249 1,684 14,711 $ 11,976 9,005 20,981 1,727 13,794 $ 10,339 10,360 20,699 1,284 12,889 $ 7,671 4.55 $ 7,014 4.15 $ 6,202 3.69 $ 5,710 3.35 $ 3,411 1.99 $ 4,012 2.35 4.50 4.09 3.65 3.32 1.97 2.32 $ 7,671 4.55 $ 7,014 4.15 $ 6,202 3.69 $ 5,434 3.19 $ 3,411 1.99 $ 4,012 2.35 4.50 2.00 4.09 1.86 3.65 1.50 3.16 1.10 1.97 1.00 2.32 .90 $ 41,834 310,837 3,871 10,787 481,741 253,341 79,668 $ 33,717 287,586 3,762 10,681 427,849 229,703 73,580 $ 32,953 253,073 3,891 10,371 387,798 211,271 63,642 $ 27,947 192,478 3,819 9,753 349,197 198,234 47,320 $ 40,308 167,096 3,717 9,527 307,506 182,295 36,095 $ 38,655 155,451 3,681 9,303 272,382 156,710 32,046 — 40,660 — 37,866 — 34,469 2,885 30,319 2,435 27,175 935 26,461 8% 12 10 39 8 9 10 10 9 10 10 8 24 8 3 1 13 10 8 — 7 12% 7 10 13 8 14 14 14 14 14 14 17 2 15 1 3 12 10 20 — 9 (1) Change in accounting principle is for a transitional goodwill impairment charge recorded in 2002 upon adoption of FAS 142, Goodwill and Other Intangible Assets. (2) Core deposits consist of noninterest-bearing deposits, interest-bearing checking, savings certiﬁcates and market rate and other savings. (3) At December 31, 2003, upon adoption of FIN 46 (revised December 2003), Consolidation of Variable Interest Entities (FIN 46R), these balances were reﬂected in long-term debt. See Note 12 (Long-Term Debt) to Financial Statements for more information. 37 Critical Accounting Policies 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 some accounting policies require that we use estimates and assumptions that may affect the value of our assets or liabilities and ﬁnancial results. Three 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, the valuation of mortgage servicing rights and pension accounting. Management has reviewed and approved these critical accounting policies and has discussed these policies with the Audit and Examination Committee. 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. 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 allocate a portion of the allowance to speciﬁc loan categories (the allocated allowance), the entire allowance (both allocated and unallocated) is used to absorb credit losses inherent in the total loan portfolio. Approximately two-thirds of the allocated allowance is determined at a pooled level for consumer loans and some segments of commercial small business loans. We use forecasting models to measure the losses inherent in these portfolios. We frequently validate and update these models to capture recent behavioral characteristics of the portfolios, as well as changes in our loss mitigation or marketing strategies. The remaining allocated allowance is for commercial loans, commercial real estate loans and lease ﬁnancing. We initially estimate this portion of the allocated allowance by applying historical loss factors statistically derived from tracking loss content associated with actual portfolio move- ments over a speciﬁed period of time, using a standardized loan grading process. 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. Also, we individually review nonperforming loans over $3 million for impairment based on cash ﬂows or collateral. We include impairment on these nonperforming loans in the allocated allowance unless it has already been recognized as a loss. The allocated allowance is supplemented by the unallo- cated allowance to adjust for imprecision and to incorporate the range of probable outcomes inherent in estimates used for the allocated allowance. The unallocated allowance is the result of our judgment of risks inherent in the portfolio, economic uncertainties, historical loss experience and other subjective factors, including industry trends, not reﬂected in the allocated allowance. The ratios of the allocated allowance and the unallocated allowance to the total allowance may change from period to period. The total allowance reﬂects management’s estimate of credit losses inherent in the loan portfolio at the balance sheet date. The allowance for credit losses, and the resulting provision, is based on judgments and assumptions, including: • general economic conditions; • loan portfolio composition; • loan loss experience; • management’s evaluation of the credit risk relating to pools of loans and individual borrowers; • sensitivity analysis and expected loss models; and • observations from our internal auditors, internal loan review staff or banking regulators. To estimate the possible range of allowance required at December 31, 2005, and the related change in provision expense, we assumed the following scenarios of a reasonably possible deterioration or improvement in loan credit quality. 38 Assumptions for deterioration in loan credit quality were: • for retail loans, a 12 basis point increase in estimated loss rates from actual 2005 loss levels, moving closer to longer term average loss rates; and • for wholesale loans, a 30 basis point increase in esti- mated loss rates, moving closer to historical averages. Assumptions for improvement in loan credit quality were: • for retail loans, an 8 basis point decrease in estimated loss rates from actual 2005 loss levels, adjusting for incremental consumer bankruptcy losses; and • for wholesale loans, no change from the essentially zero 2005 net loss performance. Under the assumptions for deterioration in loan credit quality, another $550 million in expected losses could occur and under the assumptions for improvement, a $170 million reduction in expected losses could occur. Changes in the estimate of the allowance for credit losses 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 that are highly uncertain and require a high degree of judgment. Valuation of 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 keep them after the sale or securitization of loans we originate. Purchased MSRs are capitalized at cost. Originated MSRs are recorded based on the relative fair value of the retained servicing right and the mortgage loan on the date the mortgage loan is sold. Both purchased and originated MSRs are carried at the lower of (1) the capitalized amount, net of accumulated amortization and hedge accounting adjustments, or (2) fair value. If MSRs are designated as a hedged item in a fair value hedge, the MSRs’ carrying value is adjusted for changes in fair value resulting from the application of hedge accounting. The carrying value of these MSRs is subject to a fair value test under FAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. MSRs are amortized in proportion to and over the period of estimated net servicing income. We analyze the amortization of MSRs monthly and adjust amortization to reﬂect changes in prepayment speeds, discount rates and other factors that affect estimated net servicing income. 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, discount rate, cost to service, 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 20 (Securitizations and Variable Interest Entities) and Note 21 (Mortgage Banking Activities) to Financial Statements. At the end of each quarter, we evaluate MSRs for possible impairment based on the difference between the carrying amount and current estimated fair value. To evaluate and measure impairment, we stratify the portfolio based on certain risk characteristics, including loan type and note rate. If temporary impairment exists, we establish a valuation allowance through a charge to income for those risk stratiﬁcations with an excess of amortized cost over the current fair value. If we later determine that all or part of the temporary impairment no longer exists for a particular risk stratiﬁcation, we may reduce the valuation allowance through an increase to income. Under our policy, we also evaluate other-than-temporary impairment of MSRs by considering both historical and pro- jected trends in interest rates, pay-off activity and whether the impairment could be recovered through interest rate increases. We recognize a direct write-down if we determine that the recoverability of a recorded valuation allowance is remote. A direct write-down permanently reduces the carrying value of the MSRs, while a valuation allowance (temporary impairment) can be reversed. To reduce the sensitivity of earnings to interest rate and market value ﬂuctuations, we hedge the change in value of MSRs primarily with derivative contracts. Reductions or increases in the value of the MSRs are generally offset by gains or losses in the value of the derivatives. We immediately recognize a gain or loss for the amount of change in the value of MSRs that is not offset by the change in value of the hedge instrument (i.e., hedge ineffectiveness). 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 decrease and fees from origination volume increase). Conversely, as interest rates increase, the value of the MSRs increases, while fees from origination volume tend to decline. Servicing income — net of amortization, provision for impairment and net derivative gains and losses — is recorded in mortgage banking noninterest income. We use a dynamic and sophisticated model to estimate the value of our MSRs. 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 — another key assumption in the model — is the required rate of return 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 and annual valuations as market conditions and interest rates change. Senior management reviews all assumptions quarterly. 39 Our key economic assumptions and the sensitivity of the current fair value of MSRs to an immediate adverse change in those assumptions are shown in Note 20 (Securitizations and Variable Interest Entities) to Financial Statements. 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. Pension Accounting 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 employ- ees 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) the actual return earned on plan assets, (2) historical rates of return on the various asset classes in the plan portfolio, (3) projections of returns on various asset classes, and (4) current/prospective capital mar- ket conditions and economic forecasts. Including 2005, we have used an expected rate of return of 9% on plan assets for the past nine years. In light of the market conditions in recent years, including a marked increase in volatility, we reduced the expected long-term rate of return on plan assets to 8.75% for 2006. Differences in each year, if any, between expected and actual returns are included in our unrecognized net actuarial gain or loss amount. We generally amortize any unrecognized net actuarial gain or loss in excess of a 5% corridor (as deﬁned in FAS 87, Employers’ Accounting for Pensions) in net periodic pension expense calculations over the next ﬁve years. Our average remaining service period is approximately 11 years. See Note 15 (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). We use November 30 as the measurement date for our pension assets and projected beneﬁt obligations. 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, pension expense would decrease/increase by approximately $50 million. DISCOUNT RATE We use the discount rate to determine the present value of our future beneﬁt obligations. It reﬂects the rates available on long-term high-quality ﬁxed-income debt instruments, and is reset annually on the measurement date. As the basis for determining our discount rate, we review the Moody’s Aa Corporate Bond Index, on an annualized basis, and the rate of a hypothetical portfolio using the Hewitt Yield Curve (HYC) methodology, which was developed by our indepen- dent actuary. The instruments used in both the Moody’s Aa Corporate Bond Index and the HYC consist of high quality bonds for which the timing and amount of cash outﬂows approximates the estimated payouts of our Cash Balance Plan. We lowered our discount rate to 5.75% in 2005 from 6% in 2004 and 6.5% in 2003, reﬂecting the decline in market interest rates during these periods. 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 $59 million. If we were to assume a 1% decrease in the discount rate, and keep other assumptions constant, pension expense would increase by approximately $104 million. The decrease in pension expense due to a 1% increase in discount rate differs from the increase in pension expense due to a 1% decrease in discount rate due to the impact of the 5% gain/loss corridor. 40 Earnings Performance 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% marginal tax rate. Net interest income on a taxable-equivalent basis was $18.6 billion in 2005, compared with $17.3 billion in 2004, an increase of 8%, reﬂecting solid loan growth (other than ARMs) and a relatively ﬂat net interest margin. Our net interest margin was 4.86% for 2005 and 4.89% for 2004. During a year in which the Federal Reserve raised rates eight times and the yield curve ﬂattened, our net interest margin remained essentially ﬂat compared with a year ago. Given the prospect of higher short-term interest rates and a ﬂatter yield curve, beginning in second quarter 2004, as part of our asset/liability management strategy, we sold the lowest-yielding ARMs on our balance sheet, replacing some of these loans with higher-yielding ARMs. Over the last seven quarters, we sold $65 billion in ARMs at an average yield of 4.28%. As a result, the average yield on our 1-4 family ﬁrst mortgage portfolio — which includes ARMs — increased from 5.19% on an average balance of $89.4 billion in second quarter 2004 to 6.75% on an average balance of $76.2 billion in fourth quarter 2005. At year-end 2005, yields on new ARMs being held for investment within real estate 1-4 family mortgage loans were more than 1% higher than the average yield on the ARMs sold since second quarter 2004. Our net interest margin has performed better than our peers’ due to our balance sheet repositioning actions and our ability to grow transaction and savings deposits while main- taining our deposit pricing discipline. Average earning assets increased $29.2 billion to $383.5 billion in 2005 from $354.3 billion in 2004. Loans averaged $296.1 billion in 2005, compared with $269.6 billion in 2004. Average mortgages held for sale were $39.0 billion in 2005 and $32.3 billion in 2004. Debt securities available for sale averaged $33.1 billion in both 2005 and 2004. Average core deposits are an important contributor to growth in net interest income and the net interest margin. This low-cost source of funding rose 9% from 2004. Average core deposits were $242.8 billion and $223.4 billion and funded 54.5% and 54.4% of average total assets in 2005 and 2004, respectively. Total average retail core deposits, which exclude Wholesale Banking core deposits and retail mortgage escrow deposits, for 2005 grew $18.2 billion, or 10%, from a year ago. Average mortgage escrow deposits were $16.7 billion in 2005 and $14.1 billion in 2004. Savings certiﬁcates of deposits increased on average from $18.9 billion in 2004 to $22.6 billion in 2005 and noninterest-bearing checking accounts and other core deposit categories increased on average from $204.5 billion in 2004 to $220.1 billion in 2005. Total average interest- bearing deposits increased to $194.6 billion in 2005 from $182.6 billion a year ago. Total average noninterest-bearing deposits increased to $87.2 billion in 2005 from $79.3 billion a year ago. Table 3 presents the individual components of net interest income and the net interest margin. 41 Table 3: Average Balances, Yields and Rates Paid (Taxable-Equivalent Basis) (1)(2) (in millions) EARNING ASSETS Federal funds sold, securities purchased under resale agreements and other short-term investments $ Trading assets Debt securities available for sale (3): Securities of U.S. Treasury and federal agencies Securities of U.S. states and political subdivisions Mortgage-backed securities: Federal agencies Private collateralized mortgage obligations Total mortgage-backed securities Other debt securities (4) Total debt securities available for sale (4) Mortgages held for sale (3) Loans held for sale (3) Loans: Average balance 5,448 5,411 997 3,395 19,768 5,128 24,896 3,846 33,134 38,986 2,857 Commercial and commercial real estate: Commercial Other real estate mortgage Real estate construction Lease ﬁnancing Total commercial and commercial real estate Consumer: Real estate 1-4 family ﬁrst mortgage Real estate 1-4 family junior lien mortgage Credit card Other revolving credit and installment Total consumer Foreign Total loans (5) Other Total earning assets FUNDING SOURCES Deposits: Interest-bearing checking Market rate and other savings Savings certiﬁcates Other time deposits Deposits in foreign ofﬁces Total interest-bearing deposits Short-term borrowings Long-term debt Guaranteed preferred beneﬁcial interests in Company’s subordinated debentures (6) Total interest-bearing liabilities Portion of noninterest-bearing funding sources Total funding sources Net interest margin and net interest income on a taxable-equivalent basis (7) NONINTEREST-EARNING ASSETS Cash and due from banks Goodwill Other Total noninterest-earning assets NONINTEREST-BEARING FUNDING SOURCES Deposits Other liabilities Stockholders’ equity Noninterest-bearing funding sources used to fund earning assets Net noninterest-bearing funding sources TOTAL ASSETS 58,434 29,098 11,086 5,226 103,844 78,170 55,616 10,663 43,102 187,551 4,711 296,106 1,581 $383,523 $ 3,607 129,291 22,638 27,676 11,432 194,644 24,074 79,137 — 297,855 85,668 $383,523 $ 13,173 10,705 38,389 $ 62,267 $ 87,218 21,559 39,158 (85,668) $ 62,267 $445,790 3.81 8.27 6.02 5.60 5.94 7.10 6.24 5.67 5.10 6.76 6.31 6.67 5.91 6.58 6.42 6.61 12.33 8.80 7.36 13.49 7.19 4.34 6.81 1.43 1.45 2.90 3.29 3.12 1.98 3.09 3.62 — 2.50 — 1.95 Yields/ rates 2005 Interest income/ expense Average balance Yields/ rates 2004 Interest income/ expense 3.01% 3.52 $ 1.49% 2.75 $ 164 190 38 266 1,162 283 1,445 266 2,015 2,213 146 3,951 1,836 740 309 6,836 5,016 3,679 1,315 3,794 13,804 636 21,276 68 26,072 51 1,874 656 910 357 3,848 744 2,866 — 7,458 — 7,458 $ 4,254 5,286 1,161 3,501 21,404 3,604 25,008 3,395 33,065 32,263 8,201 49,365 28,708 8,724 5,068 91,865 87,700 44,415 8,878 33,528 174,521 3,184 269,570 1,709 $354,348 $ 3,059 122,129 18,850 29,750 8,843 182,631 26,130 67,898 — 276,659 77,689 $354,348 64 145 46 267 1,248 180 1,428 236 1,977 1,737 292 2,848 1,535 463 316 5,162 4,772 2,300 1,048 3,022 11,142 487 16,791 65 21,071 13 838 425 427 124 1,827 353 1,637 — 3,817 — 3,817 4.05 8.00 6.03 5.16 5.91 7.72 6.24 5.38 3.56 5.77 5.35 5.30 6.23 5.62 5.44 5.18 11.80 9.01 6.38 15.30 6.23 3.81 5.97 .44 .69 2.26 1.43 1.40 1.00 1.35 2.41 — 1.38 — 1.08 4.86% $18,614 4.89% $17,254 $ 13,055 10,418 32,758 $ 56,231 $ 79,321 18,764 35,835 (77,689) $ 56,231 $410,579 (1) Our average prime rate was 6.19%, 4.34%, 4.12%, 4.68% and 6.91% for 2005, 2004, 2003, 2002 and 2001, respectively. The average three-month London Interbank Offered Rate (LIBOR) was 3.56%, 1.62%, 1.22%, 1.80% and 3.78% for the same years, respectively. (2) Interest rates and amounts include the effects of hedge and risk management activities associated with the respective asset and liability categories. (3) Yields are based on amortized cost balances computed on a settlement date basis. (4) Includes certain preferred securities. 42 Average balance $ 2,961 4,747 1,770 2,106 26,718 2,341 29,059 3,029 35,964 39,858 5,380 46,520 25,413 7,925 4,079 83,937 32,669 25,220 6,810 24,072 88,771 1,774 174,482 1,436 $264,828 $ 2,494 93,787 24,278 8,191 5,011 133,761 33,278 42,158 2,780 211,977 52,851 $264,828 2002 Interest income/ expense Yields/ rates 1.73% 3.58 $ 51 169 5.57 8.33 7.23 7.18 7.22 7.74 7.25 6.13 4.69 6.80 6.17 5.69 6.32 6.48 6.69 7.07 12.27 10.28 8.20 18.90 7.48 4.87 7.04 .55 .95 3.21 1.86 1.58 1.43 1.61 3.33 4.23 1.88 — 1.51 95 167 1,856 163 2,019 232 2,513 2,450 252 3,164 1,568 451 258 5,441 2,185 1,783 836 2,475 7,279 335 13,055 72 18,562 14 893 780 153 79 1,919 536 1,404 118 3,977 — 3,977 Average balance $ 2,741 2,580 2,158 2,026 27,433 1,766 29,199 3,343 36,726 23,677 4,820 48,648 24,194 8,073 4,024 84,939 23,359 17,587 6,270 23,459 70,675 1,603 157,217 1,262 $229,023 $ 2,178 80,585 29,850 1,332 6,209 120,154 33,885 34,501 1,394 189,934 39,089 $229,023 2001 Interest income/ expense Yields/ rates 3.72% 4.44 $ 102 115 137 154 1,917 148 2,065 254 2,610 1,595 317 3,896 1,934 654 278 6,762 1,761 1,619 838 2,674 6,892 333 13,987 69 18,795 35 1,675 1,530 67 246 3,553 1,273 1,826 89 6,741 — 6,741 6.55 7.98 7.19 8.55 7.27 7.80 7.32 6.72 6.58 8.01 7.99 8.10 6.90 7.96 7.54 9.20 13.36 11.40 9.75 20.82 8.90 5.50 8.24 1.59 2.08 5.13 5.04 3.96 2.96 3.76 5.29 6.40 3.55 — 2.95 Average balance Yields/ rates 2003 Interest income/ expense 1.16% 2.56 $ 49 156 58 196 1,276 120 1,396 240 1,890 3,136 251 2,876 1,405 406 277 4,964 3,115 1,836 922 2,713 8,586 396 13,946 74 19,502 7 705 529 305 67 1,613 322 1,355 121 3,411 — 3,411 4.74 8.62 7.37 6.24 7.26 7.75 7.32 5.34 3.51 6.08 5.44 5.11 6.22 5.80 5.54 5.80 12.06 9.09 6.85 18.00 6.54 4.57 6.16 .27 .66 2.53 1.20 1.11 1.00 1.08 2.52 3.66 1.37 — 1.08 $ 4,174 6,110 1,286 2,424 18,283 2,001 20,284 3,302 27,296 58,672 7,142 47,279 25,846 7,954 4,453 85,532 56,252 31,670 7,640 29,838 125,400 2,200 213,132 1,626 $318,152 $ 2,571 106,733 20,927 25,388 6,060 161,679 29,898 53,823 3,306 248,706 69,446 $318,152 $ 13,433 9,905 36,123 $ 59,461 $ 76,815 20,030 32,062 (69,446) $ 59,461 $377,613 5.08% $16,091 5.53% $14,585 5.29% $12,054 $ 13,820 9,737 33,340 $ 56,897 $ 63,574 17,054 29,120 (52,851) $ 56,897 $321,725 $ 14,608 9,514 32,222 $ 56,344 $ 55,333 13,214 26,886 (39,089) $ 56,344 $285,367 (5) Nonaccrual loans and related income are included in their respective loan categories. (6) At December 31, 2003, upon adoption of FIN 46 (revised December 2003), Consolidation of Variable Interest Entities (FIN 46R), these balances were reﬂected in long-term debt. See Note 12 (Long-Term Debt) to Financial Statements for more information. (7) Includes taxable-equivalent adjustments primarily related to tax-exempt income on certain loans and securities. The federal statutory tax rate was 35% for all years presented. 43 Card fees increased 19% to $1,458 million in 2005 from $1,230 million in 2004, predominantly due to increases in credit card accounts and credit and debit card transaction volume. Mortgage banking noninterest income increased to $2,422 million in 2005 from $1,860 million in 2004, due to an increase in net gains on mortgage loan origination/sales activities partly offset by the decline in net servicing income. Net gains on mortgage loan origination/sales activities were $1,085 million in 2005, up from $539 million in 2004, primarily due to higher origination volume. Originations were $366 billion in 2005 and $298 billion in 2004. The 1-4 family first mortgage unclosed pipeline was $50 billion at both year-end 2005 and 2004. Net servicing income was $987 million in 2005 compared with $1,037 million in 2004. Servicing income includes net derivative gains and losses and is net of amortization and impairment of MSRs, which are all inﬂuenced by both the level and direction of mortgage interest rates. The Company’s portfolio of loans serviced for others was $871 billion at December 31, 2005, up 27% from $688 billion at year-end 2004. Given a larger servicing portfolio year over year, the increase in servicing income was partly offset by higher amortization of MSRs. Servicing fees increased to $2,457 million in 2005 from $2,101 million in 2004 and amortization of MSRs increased to $1,991 million in 2005 from $1,826 million in 2004. Servicing income in 2005 also included a higher MSRs valuation allowance release of $378 million in 2005 compared with $208 million in 2004, due to higher long-term interest rates in certain quarters of 2005. The increase in fee revenue and the higher MSRs valuation allowance release were mostly offset by the decrease in net derivative gains to $143 million in 2005 from $554 million in 2004. Net losses on debt securities were $120 million for 2005, compared with $15 million for 2004. Net gains from equity investments were $511 million in 2005, compared with $394 million in 2004, primarily reﬂecting the continued strong performance of our venture capital business. We routinely review our investment portfolios and recognize impairment write-downs based primarily on issuer-speciﬁc factors and results, and our intent to hold such securities. We also consider general economic and market conditions, including industries in which venture capital investments are made, and adverse changes affecting the availability of venture capital. We determine impairment based on all of the information available at the time of the assessment, but new information or economic developments in the future could result in recognition of additional impairment. Noninterest Income Table 4: Noninterest Income (in millions) Year ended December 31, ___% Change 2004/ 2005 2003 2005/ 2004 2003 2004 Service charges on deposit accounts Trust and investment fees: $ 2,512 $ 2,417 $ 2,297 4% 5% Trust,investment and IRA fees Commissions and all other fees 1,855 1,509 581 607 1,345 592 23 (4) Total trust and investment fees Card fees Other fees: Cash network fees Charges and fees on loans All other Total other fees 2,436 2,116 1,937 1,458 1,230 1,079 180 921 180 1,022 179 756 727 678 625 1,560 1,779 1,929 15 19 — 11 7 8 12 3 9 14 1 22 8 14 Mortgage banking: Servicing income,net of amortization and provision for impairment 987 1,037 (954) (5) — Net gains on mortgage loan origination/sales activities All other Total mortgage banking Operating leases Insurance Trading assets Net gains (losses) on debt 539 1,085 3,019 350 284 447 2,512 1,860 2,422 812 1,215 571 836 1,193 523 937 1,071 502 101 23 30 (3) 2 9 securities available for sale (120) (15) 4 700 (82) (36) (26) (11) 11 4 — Net gains from equity investments Net gains on sales of loans Net gains (losses) on dispositions of operations All other Total 511 5 394 11 14 (15) 680 580 55 28 29 371 $14,445 $12,909 $12,382 30 (55) 616 (61) — 17 12 — 56 4 We earn trust, investment and IRA fees from managing and administering assets, including mutual funds, corporate trust, personal trust, employee beneﬁt trust and agency assets. At December 31, 2005, these assets totaled $783 billion, up 11% from $705 billion at December 31, 2004. At December 31, 2004, we acquired $24 billion in mutual fund assets and $5 billion in institutional investment accounts from Strong Financial Corporation (Strong Financial). When the Wells Fargo Funds® and certain Strong Financial funds merged in April 2005, we renamed our mutual fund family the Wells Fargo Advantage FundsSM. Generally, trust, investment and IRA fees are based on the market value of the assets that are managed, administered, or both. The increase in these fees was due to additional revenue from the December 31, 2004, acquisition of assets from the Strong Financial transaction and our successful efforts to grow our investment businesses. Also, we receive commissions and other fees for providing services for retail and discount brokerage customers. At December 31, 2005 and 2004, brokerage balances were $97 billion and $86 billion, respectively. Generally, these fees are based on the number of transactions executed at the customer’s direction. 44 Noninterest Expense Table 5: Noninterest Expense (in millions) Year ended December 31, 2003 2004 2005 _ _ % Change 2004/ 2005/ 2003 2004 Salaries Incentive compensation Employee beneﬁts Equipment Net occupancy Operating leases Outside professional services Contract services Travel and entertainment Outside data processing Advertising and promotion Postage Telecommunications Insurance Stationery and supplies Operating losses Security Core deposit intangibles Charitable donations Net losses from debt extinguishment All other Total $ 6,215 $ 5,393 $ 4,832 2,054 1,560 1,246 1,177 702 509 866 389 404 392 336 343 197 241 193 163 142 237 2,366 1,874 1,267 1,412 635 835 596 481 449 443 281 278 224 205 194 167 123 61 1,807 1,724 1,236 1,208 633 669 626 442 418 459 269 296 247 240 192 161 134 248 15% 12% (12) 31 11 9 (1) 3 17 3 — (10) 31 25 (28) (5) 14 9 3 7 17 (3) (20) 4 (14) (6) 25 (9) (15) — (1) (1) (6) 5 1 4 (8) (75) 11 901 1,207 $19,018 $17,573 $17,190 174 997 — (94) — (17) (10) 8 2 Noninterest expense in 2005 increased 8% to $19.0 billion from $17.6 billion in 2004, primarily due to increased mort- gage production and continued investments in new stores and additional sales-related team members. Noninterest expense in 2005 included a $117 million expense to adjust the estimated lives for certain depreciable assets, primarily building improvements, $62 million of airline lease write- downs, $56 million of integration expense and $25 million for the adoption of FIN 47, which relates to recognition of obligations associated with the retirement of long-lived assets, such as building and leasehold improvements. Home Mortgage expenses increased $426 million from 2004, reﬂecting higher production costs from an increase in loan origination volume. For 2004, employee beneﬁts included a $44 million special 401(k) contribution and charitable donations included a $217 million contribution to the Wells Fargo Foundation. See “Current Accounting Developments” for information on accounting for share-based awards, such as stock option grants. On January 1, 2006, we adopted FAS 123R, which requires that we include the cost of such grants in our income statement over the vesting period of the award. Income Tax Expense Our effective income tax rate for 2005 decreased to 33.57% from 34.87% for 2004, due primarily to higher tax-exempt income and income tax credits, and the tax beneﬁt associated with our donation of appreciated securities. Operating Segment Results Our lines of business for management reporting are Community Banking, Wholesale Banking and Wells Fargo Financial. For a more complete description of our operating segments, including additional ﬁnancial information and the underlying management accounting process, see Note 19 (Operating Segments) to Financial Statements. COMMUNITY BANKING’S net income increased 13% to $5.5 billion in 2005 from $4.9 billion in 2004. Total revenue for 2005 increased 9%, driven by loan and deposit growth and higher mortgage origination volumes. The provision for credit losses for 2005 increased $108 million, or 14%, reﬂecting incremental consumer bankruptcy ﬁlings before the mid-October legislative reform. Noninterest expense for 2005 increased $982 million, or 8%, driven by mortgage production, growth in other businesses, and investments in new stores, sales staff and technology. Average loans were $187.0 billion in 2005, up 5% from $178.9 billion in 2004. WHOLESALE BANKING’S net income was a record $1.73 billion in 2005, up 8% from $1.60 billion in 2004, driven largely by a 15% increase in earning assets, as well as very low loan losses. Average loans increased 17% to $62.2 billion in 2005 from $53.1 billion in 2004, with double-digit increases across wholesale lending businesses. The provision for credit losses decreased to $1 million in 2005 from $62 million in 2004, with loan charge-offs at very low levels throughout 2005. Noninterest income increased 13% to $3.4 billion in 2005 from $3.0 billion in 2004, largely due to the Strong Financial acquisition completed at the end of 2004. Noninterest expense increased 16% to $3.17 billion in 2005 from $2.73 billion in 2004, due to the Strong Financial acquisition and airline lease writedowns. WELLS FARGO FINANCIAL’S net income decreased 34% to $409 million in 2005 from $617 million in 2004. Net income was reduced by incremental bankruptcies related to the change in bankruptcy law and the $163 million ﬁrst quarter 2005 initial implementation of conforming to more stringent FFIEC charge-off timing rules. Also, a $100 million provision for credit losses was taken in third quarter 2005 for estimated losses from Hurricane Katrina. Total revenue rose 12% in 2005, reaching $4.7 billion, compared with $4.2 billion in 2004, due to higher net interest income. Noninterest expense increased $202 million, or 9%, in 2005 from 2004, reﬂecting investments in new consumer ﬁnance stores and additional team members. Segment results for prior periods have been revised due to the realignment of our automobile ﬁnancing businesses into Wells Fargo Financial in 2005, designed to leverage the expertise, systems and resources of the existing businesses. 45 Balance Sheet Analysis Securities Available for Sale Our securities available for sale portfolio consists of both debt and marketable equity securities. We hold debt securities available for sale primarily for liquidity, interest rate risk management and yield enhancement. Accordingly, this portfolio primarily includes very liquid, high-quality federal agency debt securities. At December 31, 2005, we held $40.9 billion of debt securities available for sale, compared with $33.0 billion at December 31, 2004, with a net unrealized gain of $591 million and $1.2 billion for the same periods, respectively. We also held $900 million of marketable equity securities available for sale at December 31, 2005, and $696 million at December 31, 2004, with a net unrealized gain of $342 million and $189 million for the same periods, respectively. The weighted-average expected maturity of debt securities available for sale was 5.9 years at December 31, 2005. Since 79% of this portfolio is mortgage-backed securities, the expected remaining maturity may differ from contractual maturity because borrowers may have the right to prepay obligations before the underlying mortgages mature. The estimated effect of a 200 basis point increase or decrease in interest rates on the fair value and the expected remaining maturity of the mortgage-backed securities available for sale portfolio is shown in Table 6. Table 6: Mortgage-Backed Securities (in billions) At December 31, 2005 At December 31, 2005, Fair value $32.4 Net unrealized gain (loss) Remaining maturity $ .4 5.3 yrs. assuming a 200 basis point: Increase in interest rates Decrease in interest rates 29.9 33.5 (2.1) 1.5 7.5 yrs. 2.0 yrs. See Note 5 (Securities Available for Sale) to Financial Statements for securities available for sale by security type. Loan Portfolio A comparative schedule of average loan balances is included in Table 3; year-end balances are in Note 6 (Loans and Allowance for Credit Losses) to Financial Statements. Loans averaged $296.1 billion in 2005, compared with $269.6 billion in 2004, an increase of 10%. Total loans at December 31, 2005, were $310.8 billion, compared with $287.6 billion at year-end 2004, an increase of 8%. Average 1-4 family ﬁrst mortgages decreased $9.5 billion, or 11%, and average junior liens increased $11.2 billion, or 25%, in 2005 compared with a year ago. Average commercial and commercial real estate loans increased $12.0 billion, or 13%, in 2005 compared with a year ago. Average mortgages held for sale increased $6.7 billion, or 21%, to $39.0 billion in 46 2005 from $32.3 billion in 2004, due to higher origination volume. Residential mortgage originations of $366 billion were up 23% from $298 billion in 2004. Loans held for sale decreased to $612 million at December 31, 2005, from $8.7 billion a year ago, due to the transfer of student loans held for sale to the held for investment portfolio. Our decision to hold these loans for investment was based on present yields and our intent and ability to hold this portfolio for the foreseeable future. Table 7 shows contractual loan maturities and interest rate sensitivities for selected loan categories. Table 7: Maturities for Selected Loan Categories (in millions) December 31, 2005 Total Within one year After one year through ﬁveyears After ﬁve years Selected loan maturities: Commercial Other real estate mortgage Real estate construction Foreign Total selected loans $18,748 3,763 5,081 525 $28,117 11,777 6,887 $31,627 $11,177 $ 61,552 28,545 13,005 13,406 1,438 3,995 1,032 5,552 $54,286 $26,652 $109,055 Sensitivity of loans due after one year to changes in interest rates: Loans at ﬁxed interest rates Loans at ﬂoating/variable interest rates Total selected loans $11,145 $ 7,453 43,141 19,199 $54,286 $26,652 Deposits Year-end deposit balances are in Table 8. Comparative detail of average deposit balances is included in Table 3. Average core deposits funded 54.5% and 54.4% of average total assets in 2005 and 2004, respectively. Total average interest-bearing deposits rose from $182.6 billion in 2004 to $194.6 billion in 2005. Total average noninterest-bearing deposits rose from $79.3 billion in 2004 to $87.2 billion in 2005. Savings certiﬁcates increased on average from $18.9 billion in 2004 to $22.6 billion in 2005. Table 8: Deposits (in millions) December 31, 2004 2005 % Change Noninterest-bearing Interest-bearing checking Market rate and other savings Savings certiﬁcates Core deposits Other time deposits Deposits in foreign ofﬁces $ 87,712 3,324 $ 81,082 3,122 134,811 27,494 253,341 46,488 14,621 126,648 18,851 229,703 36,622 8,533 Total deposits $314,450 $274,858 8% 6 6 46 10 27 71 14 Off-Balance Sheet Arrangements and Aggregate Contractual Obligations Off-Balance Sheet Arrangements, Variable Interest Entities, Guarantees and Other Commitments We consolidate our majority-owned subsidiaries and sub- sidiaries in which we are the primary beneﬁciary. Generally, we use the equity method of accounting if we own at least 20% of an entity and we carry the investment at cost if we own less than 20% of an entity. See Note 1 (Summary of Signiﬁcant Accounting Policies) to Financial Statements for our consolidation policy. In the ordinary course of business, we engage in ﬁnancial transactions that are not recorded on the balance sheet, or may be recorded on the balance sheet in amounts that are different than 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 or (4) optimize capital, and are accounted for in accordance with U.S. generally accepted accounting principles (GAAP). Almost all of our off-balance sheet arrangements result from securitizations. We routinely securitize home mortgage loans and, from time to time, other ﬁnancial assets, including student loans, commercial mortgages and automobile receiv- ables. We normally structure loan securitizations as sales, in accordance with FAS 140. This involves the transfer of ﬁnancial assets to certain qualifying special-purpose entities that we are not required to consolidate. In a securitization, we can convert the assets into cash earlier than if we held the assets to maturity. Special-purpose entities used in these types of securitizations obtain cash to acquire assets by issuing securities to investors. In a securitization, we record a liability related to standard representations and warranties we make to purchasers and issuers for receivables transferred. Also, we generally retain the right to service the transferred receivables and to repurchase those receivables from the special-purpose entity if the outstanding balance of the receivable falls to a level where the cost exceeds the beneﬁts of servicing such receivables. At December 31, 2005, securitization arrangements sponsored by the Company consisted of $121 billion in securitized loan receivables, including $75 billion of home mortgage loans. At December 31, 2005, the retained servicing rights and other beneﬁcial interests related to these securiti- zations were $4,426 million, consisting of $3,501 million in securities, $784 million in servicing assets and $141 million in other retained interests. Related to our securitizations, we have committed to provide up to $40 million in credit enhancements. We also hold variable interests greater than 20% but less than 50% in certain special-purpose entities formed to provide affordable housing and to securitize corporate debt that had approximately $3 billion in total assets at December 31, 2005. We are not required to consolidate these entities. Our maximum exposure to loss as a result of our involvement with these unconsolidated variable interest entities was approximately $870 million at December 31, 2005, predominantly representing investments in entities formed to invest in affordable housing. We, however, expect to recover our investment over time primarily through realization of federal low-income housing tax credits. For more information on securitizations including sales proceeds and cash ﬂows from securitizations, see Note 20 (Securitizations and Variable Interest Entities) to Financial Statements. Home Mortgage, in the ordinary course of business, origi- nates a portion of its mortgage loans through unconsolidated joint ventures in which we own an interest of 50% or less. Loans made by these joint ventures are funded by Wells Fargo Bank, N.A., or an afﬁliated entity, through an established line of credit and are subject to speciﬁed underwriting criteria. At December 31, 2005, the total assets of these mortgage origination joint ventures were approximately $55 million. We provide liquidity to these joint ventures in the form of outstanding lines of credit and, at December 31, 2005, these liquidity commitments totaled $358 million. We also hold interests in other unconsolidated joint ventures formed with unrelated third parties to provide efﬁciencies from economies of scale. A third party manages our real estate lending services joint ventures and provides customers title, escrow, appraisal and other real estate related services. Our merchant services joint venture includes credit card processing and related activities. At December 31, 2005, total assets of our real estate lending and merchant services joint ventures were approximately $715 million. When we acquire brokerage, asset management and insurance agencies, the terms of the acquisitions may provide for deferred payments or additional consideration, based on certain performance targets. At December 31, 2005, the amount of contingent consideration we expected to pay was not signiﬁcant to our ﬁnancial statements. As a ﬁnancial services provider, we routinely commit to extend credit, including loan commitments, standby letters of credit and ﬁnancial guarantees. A signiﬁcant portion of commitments to extend credit may expire without being drawn upon. These commitments are subject to the same credit policies and approval process used for our loans. For more information, see Note 6 (Loans and Allowance for Credit Losses) and Note 24 (Guarantees) to Financial Statements. In our venture capital and capital markets businesses, we commit to fund equity investments directly to investment funds and to speciﬁc private companies. The timing of future cash requirements to fund these commitments generally depends on the venture capital investment cycle, the period over which privately-held companies are funded by venture capital investors and ultimately sold or taken public. This 47 cycle can vary based on market conditions and the industry in which the companies operate. We expect that many of these investments will become public, or otherwise become liquid, before the balance of unfunded equity commitments is used. At December 31, 2005, these commitments were approximately $650 million. Our other investment commit- ments, principally related to affordable housing, civic and other community development initiatives, were approximately $465 million at December 31, 2005. In the ordinary course of business, we enter into indem- niﬁcation agreements, including underwriting agreements relating to offers and sales of our securities, acquisition agreements, and various other business transactions or arrangements, such as relationships arising from service as a director or ofﬁcer of the Company. For more information, see Note 24 (Guarantees) to Financial Statements. Contractual Obligations In addition to the contractual commitments and arrange- ments described above, which, depending on the nature of the obligation, may or may not require use of our resources, we enter into other contractual obligations in the ordinary course of business, including debt issuances for the funding of operations and leases for premises and equipment. Table 9 summarizes these contractual obligations at December 31, 2005, except obligations for short-term borrowing arrangements and pension and postretirement beneﬁt plans. More information on these obligations is in Note 11 (Short-Term Borrowings) and Note 15 (Employee Beneﬁts and Other Expenses) to Financial Statements. The table also excludes other commitments more fully described under “Off-Balance Sheet Arrangements, Variable Interest Entities, Guarantees and Other Commitments.” We enter into derivatives, which create contractual obligations, as part of our interest rate risk management process, for our customers or for other trading activities. See “Asset/Liability and Market Risk Management” in this report and Note 26 (Derivatives) to Financial Statements for more information. Transactions with Related Parties FAS 57, Related Party Disclosures, requires disclosure of material related party transactions, other than compensation arrangements, expense allowances and other similar items in the ordinary course of business. The Company had no related party transactions required to be reported under FAS 57 for the years ended December 31, 2005, 2004 and 2003. Table 9: Contractual Obligations (in millions) Contractual payments by period: Deposits Long-term debt (2) Operating leases Purchase obligations (3) Total contractual obligations Note(s) to Financial Statements Less than 1 year 1-3 years 3-5 years More than 5 years Indeterminate maturity (1) Total 10 7, 12 7 $80,461 11,124 514 548 $92,647 $ 5,785 27,704 786 244 $34,519 $ 1,307 15,869 535 28 $17,739 $ 231 24,971 898 — $26,100 $226,666 — — — $226,666 $314,450 79,668 2,733 820 $397,671 (1) Represents interest-bearing and noninterest-bearing checking, market rate and other savings accounts. (2) Includes capital leases of $14 million. (3) Represents agreements to purchase goods or services. 48 Risk Management Credit Risk Management Process Our credit risk management process provides for decentral- ized management and accountability by our lines of business. Our overall credit process includes comprehensive credit policies, frequent and detailed risk measurement and model- ing, extensive credit training programs and a continual loan audit review process. In addition, regulatory examiners review and perform detailed tests of our credit underwriting, loan administration and allowance processes. Managing credit risk is a company-wide process. We have credit policies for all banking and nonbanking operations incurring credit risk with customers or counterparties that provide a consistent, prudent approach to credit risk man- agement. We use detailed tracking and analysis to measure credit performance and exception rates and we routinely review and modify credit policies as appropriate. We have corporate data integrity standards to ensure accurate and complete credit performance reporting. We strive to identify problem loans early and have dedicated, specialized collec- tion and work-out units. The Chief Credit Ofﬁcer, who reports directly to the Chief Executive Ofﬁcer, provides company-wide credit over- sight. Each business unit with direct credit risks has a credit ofﬁcer and has the primary responsibility for managing its own credit risk. The Chief Credit Ofﬁcer delegates authority, limits and other requirements to the business units. These delegations are routinely reviewed and amended if there are signiﬁcant changes in personnel, credit performance, or busi- ness requirements. The Chief Credit Ofﬁcer is a member of the Company’s Management Committee. Our business units and the ofﬁce of the Chief Credit Ofﬁcer periodically review all credit risk portfolios to ensure that the risk identiﬁcation processes are functioning properly and that credit standards are followed. Business units con- duct quality assurance reviews to ensure that loans meet portfolio or investor credit standards. Our loan examiners and internal auditors also independently review portfolios with credit risk. Our primary business focus in middle-market commercial and residential real estate, auto and small consumer lending, results in portfolio diversiﬁcation. We ensure that we use appropriate methods to understand and underwrite risk. In our wholesale portfolios, larger or more complex loans are individually underwritten and judgmentally risk rated. They are periodically monitored and prompt corrective actions are taken on deteriorating loans. Smaller, more homogeneous loans are approved and monitored using statistical techniques. Retail loans are typically underwritten with statistical decision-making tools and are managed throughout their life cycle on a portfolio basis. The Chief Credit Ofﬁcer establishes corporate standards for model development and validation to ensure sound credit decisions and regulatory compliance. Each business unit completes quarterly asset quality fore- casts to quantify its intermediate-term outlook for loan losses and recoveries, nonperforming loans and market trends. To make sure our overall allowance for credit losses is adequate we conduct periodic stress tests. This includes a portfolio loss simulation model that simulates a range of possible losses for various sub-portfolios assuming various trends in loan quality. We assess loan portfolios for geographic, industry, or other concentrations and use mitigation strategies, which may include loan sales, syndications or third party insurance, to minimize these concentrations, as we deem necessary. We routinely review and evaluate risks that are not borrower speciﬁc but that may inﬂuence the behavior of a particular credit, group of credits or entire sub-portfolios. We also assess risk for particular industries, geographic locations such as states or Metropolitan Statistical Areas (MSAs) and speciﬁc macroeconomic trends. NONACCRUAL LOANS AND OTHER ASSETS Table 10 shows the ﬁve-year trend for nonaccrual loans and other assets. We generally place loans on nonaccrual status when: • the full and timely collection of interest or principal becomes uncertain; • they are 90 days (120 days with respect to real estate 1-4 family ﬁrst and junior lien mortgages) past due for interest or principal (unless both well-secured and in the process of collection); or • part of the principal balance has been charged off. Note 1 (Summary of Signiﬁcant Accounting Policies) to Financial Statements describes our accounting policy for nonaccrual loans. The decrease in nonaccrual loans was primarily due to payoffs of commercial and commercial real estate nonaccrual loans. We expect that the amount of nonaccrual loans will change due to portfolio growth, portfolio seasoning, routine problem loan recognition and resolution through collections, sales or charge-offs. The performance of any one loan can be affected by external factors, such as economic conditions, or factors particular to a borrower, such as actions of a borrower’s management. If interest due on the book balances of all nonaccrual loans (including loans that were but are no longer on nonac- crual at year end) had been accrued under the original terms, approximately $85 million of interest would have been recorded in 2005, compared with payments of $35 million recorded as interest income. Most of the foreclosed assets at December 31, 2005, have been in the portfolio one year or less. 49 Table 10: Nonaccrual Loans and Other Assets (in millions) Nonaccrual loans: Commercial and commercial real estate: Commercial Other real estate mortgage Real estate construction Lease ﬁnancing Total commercial and commercial real estate Consumer: Real estate 1-4 family ﬁrst mortgage Real estate 1-4 family junior lien mortgage Other revolving credit and installment Total consumer Foreign Total nonaccrual loans (1) As a percentage of total loans Foreclosed assets Real estate investments (2) Total nonaccrual loans and other assets As a percentage of total loans December 31, 2001 2004 2003 2002 2005 $ 286 165 31 45 527 471 144 171 786 25 1,338 $ 345 229 57 68 699 386 92 160 638 21 1,358 $ 592 285 56 73 1,006 274 87 88 449 3 1,458 $ 796 192 93 79 1,160 230 49 48 327 5 1,492 .43% .47% .58% .78% 191 2 $1,531 212 2 $1,572 198 6 $1,662 195 4 $1,691 .49% .55% .66% .88% $ 827 210 145 163 1,345 205 22 59 286 9 1,640 .98% 160 2 $1,802 1.08% (1) Includes impaired loans of $190 million, $309 million, $629 million, $612 million and $823 million at December 31, 2005, 2004, 2003, 2002 and 2001, respectively. (See Note 1 (Summary of Signiﬁcant Accounting Policies) and Note 6 (Loans and Allowance for Credit Losses) to Financial Statements for further discussion of impaired loans.) (2) Real estate investments (contingent interest loans accounted for as investments) that would be classiﬁed as nonaccrual if these assets were recorded as loans. Real estate investments totaled $84 million, $4 million, $9 million, $9 million and $24 million at December 31, 2005, 2004, 2003, 2002 and 2001, respectively. Table 11: Loans 90 Days or More Past Due and Still Accruing (Excluding Insured/Guaranteed GNMA Advances) (in millions) Commercial and commercial real estate: Commercial Other real estate mortgage Real estate construction Total commercial and commercial real estate Consumer: Real estate 1-4 family ﬁrst mortgage Real estate 1-4 family junior lien mortgage Credit card Other revolving credit and installment Total consumer Foreign Total December 31, 2001 2003 2005 2004 2002 $ 18 $ 26 $ 87 $ 92 $ 60 13 9 6 6 9 6 7 11 22 47 40 38 102 110 129 103 148 117 104 145 50 159 290 602 41 $683 40 150 306 644 76 29 134 271 551 43 18 130 282 534 28 17 116 268 546 23 $758 $696 $672 $698 LOANS 90 DAYS OR MORE PAST DUE AND STILL ACCRUING Loans in this category are 90 days or more past due as to interest or principal and still accruing, because they are (1) well-secured and in the process of collection or (2) real estate 1-4 family ﬁrst mortgage loans or consumer loans exempt under regulatory rules from being classiﬁed as nonaccrual. The total of loans 90 days or more past due and still accruing was $3,606 million, $2,578 million, $2,337 million, $672 million and $698 million at December 31, 2005, 2004, 2003, 2002 and 2001, respectively. At December 31, 2005, 2004, and 2003, the total included $2,923 million, $1,820 million and $1,641 million, respectively, in advances pursuant to our servicing agreements to Government National Mortgage Association (GNMA) mortgage pools whose repayments are insured by the Federal Housing Administration or guaranteed by the Department of Veterans Affairs. Before clarifying guidance issued in 2003 as to classiﬁcation as loans, GNMA advances were included in other assets. Table 11 provides detail by loan category excluding GNMA advances. 50 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 assume that our allowance for credit losses as a percentage of charge-offs and nonaccrual loans will change at different points in time based on credit performance, loan mix and collateral values. Any loan with past due principal or interest that is not both well-secured and in the process of collection generally is charged off (to the extent that it exceeds the fair value of any related collateral) based on loan category after a deﬁned period of time. Also, a loan is charged off when clas- siﬁed as a loss by either internal loan examiners or regulatory examiners. The detail of the changes in the allowance for credit losses, including charge-offs and recoveries by loan category, is in Note 6 (Loans and Allowance for Credit Losses) to Financial Statements. At December 31, 2005, the allowance for loan losses was $3.87 billion, or 1.25% of total loans, compared with $3.76 billion, or 1.31%, at December 31, 2004, and $3.89 billion, or 1.54%, at December 31, 2003. The decrease in the ratio of the allowance for loan losses to total loans was primarily due to a continued shift toward a higher percentage of consumer loans in our portfolio, including consumer loans and some small business loans, which have shorter loss emergence periods, and home mortgage loans, which have inherently lower losses that emerge over a longer time frame compared to other consumer products. We have historically experienced lower losses on our residential real estate secured consumer loan portfolio. The allowance for credit losses was $4.06 billion at December 31, 2005, and $3.95 billion at December 31, 2004. The ratio of the allowance for credit losses to net charge-offs was 178% and 237% at December 31, 2005 and 2004, respectively. This ratio ﬂuctuates from period to period and the decrease in 2005 reﬂects increased loss rates within the various consumer and small business portfolios impacted by higher consumer bankruptcies in fourth quarter 2005. The ratio of the allowance for credit losses to total nonac- crual loans was 303% and 291% at December 31, 2005 and 2004, respectively. This ratio may ﬂuctuate signiﬁcantly from period to period due to such factors as the mix of loan types in the portfolio, borrower credit strength and the value and marketability of collateral. Over half of nonaccrual loans were home mortgages and other consumer loans at December 31, 2005. Nonaccrual loans are generally written down to a net realizable value at the time they are placed on nonaccrual and accounted for on a cost recovery basis. The provision for credit losses totaled $2.38 billion in 2005, and $1.72 billion in both 2004 and 2003. In 2005, the provision included $100 million in excess of net charge-offs, which was our estimate of probable credit losses related to Hurricane Katrina. We continue to work with customers under various payment moratoriums and forbearance programs to re-evaluate and reﬁne our estimates as more information becomes available and can be conﬁrmed in subsequent quarters. Net charge-offs in 2005 were .77% of average total loans, compared with .62% in 2004 and .81% in 2003. Higher net charge-offs in 2005 included the additional credit losses from the change in bankruptcy laws and conforming Wells Fargo Financial to FFIEC charge-off rules. A portion of these bankruptcy charge-offs represent an acceleration of charge-offs that would have likely occurred in 2006. The increase in consumer bankruptcies primarily impacted our credit card, unsecured consumer loans and lines, auto and small business portfolios. The reserve for unfunded credit commitments was $186 million at December 31, 2005, and $188 million at December 31, 2004, less than 5% of the total allowance for credit losses related to this potential risk for both years. The allocated component of the allowance for credit losses was $3.41 billion at December 31, 2005, and $3.06 billion at December 31, 2004, an increase of $347 million year over year. Changes in the allocated allowance reﬂect changes in statistically derived loss estimates, historical loss experience, and current trends in borrower risk and/or general economic activity on portfolio performance. The unallocated allowance decreased to $648 million, or 16% of the allowance for credit losses, at December 31, 2005, from $888 million, or 22%, at December 31, 2004. We consider the allowance for credit losses of $4.06 billion adequate to cover credit losses inherent in the loan portfolio, including unfunded credit commitments, at December 31, 2005. The process for determining the adequacy of the allowance for credit losses is critical to our ﬁnancial results. It requires difﬁcult, subjective and complex judgments, as a result of the need to make estimates about the effect of matters that are uncertain. (See “Financial Review – Critical Accounting Policies – Allowance for Credit Losses.”) Therefore, we cannot provide assurance that, in any particular period, we will not have sizeable credit losses in relation to the amount reserved. We may need to signiﬁcantly adjust the allowance for credit losses, considering current factors at the time, including economic conditions and ongoing internal and external examination processes. Our process for determining the adequacy of the allowance for credit losses is discussed in Note 6 (Loans and Allowance for Credit Losses) to Financial Statements. 51 Asset/Liability and Market Risk Management Asset/liability management involves the evaluation, monitoring and management of interest rate risk, market risk, liquidity and funding. The Corporate Asset/Liability Management Committee (Corporate ALCO) — which oversees these risks and reports periodically to the Finance Committee of the Board of Directors — consists of senior financial and business executives. Each of our principal business groups—Community Banking (including Mortgage Banking), Wholesale Banking and Wells Fargo Financial — have individual asset/liability management committees and processes linked to the Corporate ALCO process. INTEREST RATE RISK Interest rate risk, which potentially can have a signiﬁcant earnings impact, is an integral part of being a ﬁnancial inter- mediary. We are subject to interest rate risk because: • assets and liabilities may mature or reprice at different times (for example, if assets reprice faster than liabilities and interest rates are generally falling, earnings will initially decline); • assets and liabilities may reprice at the same time but by different amounts (for example, when the general level of interest rates is falling, we may reduce rates paid on checking and savings deposit accounts by an amount that is less than the general decline in market interest rates); • short-term and long-term market interest rates may change by different amounts (for example, the shape of the yield curve may affect new loan yields and funding costs differently); or • the remaining maturity of various assets or liabilities may shorten or lengthen as interest rates change (for example, if long-term mortgage interest rates decline sharply, mortgage-backed securities held in the securities available for sale portfolio may prepay signiﬁcantly earlier than anticipated—which could reduce portfolio income). Interest rates may also have a direct or indirect effect on loan demand, credit losses, mortgage origination volume, the value of MSRs, the value of the pension liability and other sources of earnings. We assess interest rate risk by comparing our most likely earnings plan with various earnings simulations using many interest rate scenarios that differ in the direction of interest rate changes, the degree of change over time, the speed of change and the projected shape of the yield curve. For exam- ple, as of December 31, 2005, our most recent simulation indicated estimated earnings at risk of less than 1% of our most likely earnings plan over the next 12 months using a scenario in which the federal funds rate dropped 200 basis points to 2.25% and the 10-year Constant Maturity Treasury bond yield dropped 125 basis points to 3.25% over the same period. Simulation estimates depend on, and will change with, the size and mix of our actual and projected 52 balance sheet at the time of each simulation. Due to timing differences between the quarterly valuation of MSRs and the eventual impact of interest rates on mortgage banking volumes, earnings at risk in any particular quarter could be higher than the average earnings at risk over the twelve month simulation period, depending on the path of interest rates and on our MSRs hedging strategies. See “Mortgage Banking Interest Rate Risk” below. We use exchange-traded and over-the-counter interest rate derivatives to hedge our interest rate exposures. The notional or contractual amount, credit risk amount and estimated net fair values of these derivatives as of December 31, 2005 and 2004, are presented in Note 26 (Derivatives) to Financial Statements. We use derivatives for asset/liability management in three ways: • to convert a major portion of our long-term ﬁxed-rate debt, which we issue to ﬁnance the Company, from ﬁxed-rate payments to ﬂoating-rate payments by entering into receive-ﬁxed swaps; • to convert the cash ﬂows from selected asset and/or liability instruments/portfolios from ﬁxed-rate payments to ﬂoating-rate payments or vice versa; and • to hedge our mortgage origination pipeline, funded mortgage loans and MSRs using interest rate swaps, swaptions, futures, forwards and options. MORTGAGE BANKING INTEREST RATE RISK We originate, fund and service mortgage loans, which subjects us to various risks, including credit, liquidity and interest rate risks. We avoid unwanted credit and liquidity risks by selling or securitizing virtually all of the long-term ﬁxed-rate mort- gage loans we originate and most of the ARMs we originate. From time to time, we hold originated ARMs in portfolio as an investment for our growing base of core deposits, and we may subsequently sell some or all of these ARMs as part of our corporate asset/liability management. While credit and liquidity risks are relatively low for mortgage banking activities, interest rate risk can be substantial. Changes in interest rates may potentially impact origination and servicing fees, the value of our MSRs, the income and expense associated with instruments used to hedge changes in the value of MSRs, and the value of derivative loan commitments extended to mortgage applicants. Interest rates impact the amount and timing of origina- tion and servicing fees because consumer demand for new mortgages and the level of reﬁnancing activity are sensitive to changes in mortgage interest rates. Typically, a decline in mortgage interest rates will lead to an increase in mortgage originations and fees and, depending on our ability to retain market share, may also lead to an increase in servicing fees. Given the time it takes for consumer behavior to fully react to interest rate changes, as well as the time required for processing a new application, providing the commitment, and securitizing and selling the loan, interest rate changes will impact origination and servicing fees with a lag. The amount and timing of the impact on origination and servicing fees will depend on the magnitude, speed and duration of the change in interest rates. Under GAAP, MSRs are adjusted at the end of each quarter to the lower of cost or market. While the valuation of MSRs can be highly subjective and involve complex judgments by management about matters that are inherently unpredictable, changes in interest rates inﬂuence a variety of assumptions included in the periodic valuation of MSRs. Assumptions affected include prepayment speed, expected returns and potential risks on the servicing asset portfolio, the value of escrow balances and other servicing valuation elements impacted by interest rates. A decline in interest rates increases the propensity for reﬁnancing, reduces the expected duration of the servicing portfolio and therefore reduces the estimated value of MSRs. This reduction in value causes a charge to income as a result of increasing the valuation allowance for potential MSRs impairment (net of any gains on derivatives used to hedge MSRs). We typically do not fully hedge with financial instruments (derivatives or securities) all of the potential decline in the value of our MSRs to a decline in interest rates because the potential increase in origination/servicing fees in that scenario provides a partial “natural business hedge.” In a rising rate period, when the MSRs valuation is not fully hedged with derivatives, the amount of valuation allowance that can be recaptured into income will typically — although not always — exceed the losses on any derivatives hedging the MSRs. Hedging the various sources of interest rate risk in mort- gage banking is a complex process that requires sophisticated modeling and constant monitoring. While we attempt to balance these various aspects of the mortgage business, there are several potential risks to earnings: • MSRs valuation changes associated with interest rate changes are recorded in earnings immediately within the accounting period in which those interest rate changes occur, whereas the impact of those same changes in interest rates on origination and servicing fees occur with a lag and over time. Thus, the mortgage business could be protected from adverse changes in interest rates over a period of time on a cumulative basis but still display large variations in income in any accounting period. • The degree to which the “natural business hedge” off- sets changes in MSRs valuations is imperfect, varies at different points in the interest rate cycle, and depends not just on the direction of interest rates but on the pattern of quarterly interest rate changes. For example, given the relatively high level of reﬁnancing activity in recent years and the increase in interest rates in 2005, any signiﬁcant increase in reﬁnancing activity would likely occur only if rates drop substantially from year- end 2005 levels. • Origination volumes, the valuation of MSRs and hedging results and associated costs are also impacted by many factors. Such factors include the mix of new business between ARMs and ﬁxed-rated mortgages, the relation- ship between short-term and long-term interest rates, the degree of volatility in interest rates, the relationship between mortgage interest rates and other interest rate markets, and other interest rate factors. Many of these factors are hard to predict and we may not be able to directly or perfectly hedge their effect. • While our hedging activities are designed to balance our mortgage banking interest rate risks, the ﬁnancial instruments we use, including mortgage, U.S. Treasury, and LIBOR-based futures, forwards, swaps and options, may not perfectly correlate with the values and income being hedged. Our MSRs totaled $12.5 billion, net of a valuation allowance of $1.2 billion at December 31, 2005, and $7.9 billion, net of a valuation allowance of $1.6 billion, at December 31, 2004. The weighted-average note rate of our owned servicing portfolio was 5.72% at December 31, 2005, and 5.75% at December 31, 2004. Our MSRs were 1.44% of mortgage loans serviced for others at December 31, 2005, and 1.15% at December 31, 2004. As part of our mortgage banking activities, we enter into commitments to fund residential mortgage loans at speciﬁed times in the future. A mortgage loan commitment is an interest rate lock that binds us to lend funds to a potential borrower at a speciﬁed interest rate and within a speciﬁed period of time, generally up to 60 days after inception of the rate lock. These loan commitments are derivative loan commitments if the loans that will result from the exercise of the commitments will be held for sale. Under FAS 133, Accounting for Derivative Instruments and Hedging Activities (as amended), these derivative loan commitments are recognized at fair value on the consolidated balance sheet with changes in their fair values recorded as part of income from mortgage banking operations. Consistent with EITF 02-3, Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities, and SEC Staff Accounting Bulletin No. 105, Application of Accounting Principles to Loan Commitments, we record no value for the loan commitment at inception. Subsequent to inception, we recognize fair value of the derivative loan commitment based on estimated changes in the fair value of the underlying loan that would result from the exercise of that commitment and on changes in the probability that the loan will fund within the terms of the commitment. The value of that loan is affected primarily by changes in interest rates and the passage of time. We also apply a fall-out factor to the valuation of the derivative loan commitment for the probability that the loan will not fund within the terms of the commitments. The value of the MSRs is recognized only after the servicing asset has been contractually separated from the underlying loan by sale or securitization. 53 Outstanding derivative loan commitments expose us to the risk that the price of the loans underlying the commitments might decline due to increases in mortgage interest rates from inception of the rate lock to the funding of the loan. To minimize this risk, we utilize options, futures and forwards to economically hedge the potential decreases in the values of the loans that could result from the exercise of the loan commitments. We expect that these derivative ﬁnancial instruments will experience changes in fair value that will either fully or partially offset the changes in fair value of the derivative loan commitments. MARKET RISK – TRADING ACTIVITIES From a market risk perspective, our net income is exposed to changes in interest rates, credit spreads, foreign exchange rates, equity and commodity prices and their implied volatilities. The primary purpose of our trading businesses is to accommodate customers in the management of their market price risks. Also, we take positions based on market expectations or to beneﬁt from price differences between ﬁnancial instruments and markets, subject to risk limits established and monitored by Corporate ALCO. All securities, foreign exchange transactions, commodity transactions and derivatives — transacted with customers or used to hedge capital market transactions with customers — are carried at fair value. The Institutional Risk Committee establishes and monitors counterparty risk limits. The notional or contractual amount, credit risk amount and estimated net fair value of all customer accommodation derivatives at December 31, 2005 and 2004, are included in Note 26 (Derivatives) to Financial Statements. Open, “at risk” positions for all trading business are monitored by Corporate ALCO. The standardized approach for monitoring and reporting market risk for the trading activities is the value-at-risk (VAR) metrics complemented with factor analysis and stress testing. VAR measures the worst expected loss over a given time interval and within a given conﬁdence interval. We measure and report daily VAR at 99% conﬁdence interval based on actual changes in rates and prices over the past 250 days. The analysis captures all ﬁnancial instruments that are considered trading positions. The average one-day VAR throughout 2005 was $18 million, with a lower bound of $11 million and an upper bound of $24 million. MARKET RISK – EQUITY MARKETS We are directly and indirectly affected by changes in the equity markets. We make and manage direct equity invest- ments in start-up businesses, emerging growth companies, management buy-outs, acquisitions and corporate recapital- izations. We also invest in non-afﬁliated funds that make similar private equity investments. These private equity investments are made within capital allocations approved by management and the Board of Directors (the Board). 54 The Board reviews business developments, key risks and historical returns for the private equity investments at least annually. Management reviews these investments at least quarterly and assesses them for possible other-than-temporary impairment. For nonmarketable investments, the analysis is based on facts and circumstances of each investment and the expectations for that investment’s cash ﬂows and capital needs, the viability of its business model and our exit strategy. Private equity investments totaled $1,537 million at December 31, 2005, and $1,449 million at December 31, 2004. We also have marketable equity securities in the available for sale investment portfolio, including securities relating to our venture capital activities. We manage these investments within capital risk limits approved by management and the Board and monitored by Corporate ALCO. Gains and losses on these securities are recognized in net income when realized and other-than-temporary impairment may be periodically recorded when identiﬁed. The initial indicator of impairment for marketable equity securities is a sustained decline in market price below the amount recorded for that investment. We consider a variety of factors, such as the length of time and the extent to which the market value has been less than cost; the issuer’s ﬁnancial condition, capital strength, and near-term prospects; any recent events speciﬁc to that issuer and economic conditions of its industry; and, to a lesser degree, our investment horizon in relationship to an anticipated near-term recovery in the stock price, if any. The fair value of marketable equity securities was $900 million and cost was $558 million at December 31, 2005, and $696 million and $507 million, respectively, at December 31, 2004. Changes in equity market prices may also indirectly affect our net income (1) by affecting the value of third party assets under management and, hence, fee income, (2) by affecting particular borrowers, whose ability to repay principal and/or interest may be affected by the stock market, or (3) by affecting brokerage activity, related commission income and other business activities. Each business line monitors and manages these indirect risks. LIQUIDITY AND FUNDING The objective of effective liquidity management is to ensure that we can meet customer loan requests, customer deposit maturities/withdrawals and other cash commitments efﬁ- ciently under both normal operating conditions and under unpredictable circumstances of industry or market stress. To achieve this objective, Corporate ALCO establishes and monitors liquidity guidelines that require sufﬁcient asset-based liquidity to cover potential funding requirements and to avoid over-dependence on volatile, less reliable funding markets. We set these guidelines for both the consolidated balance sheet and for the Parent to ensure that the Parent is a source of strength for its regulated, deposit-taking banking subsidiaries. Debt securities in the securities available for sale portfolio provide asset liquidity, in addition to the immediately liquid resources of cash and due from banks and federal funds sold and securities purchased under resale agreements. The weighted- average expected remaining maturity of the debt securities within this portfolio was 5.9 years at December 31, 2005. Of the $40.3 billion (cost basis) of debt securities in this portfolio at December 31, 2005, $5.1 billion, or 13%, is expected to mature or be prepaid in 2006 and an additional $5.5 billion, or 14%, in 2007. Asset liquidity is further enhanced by our ability to sell or securitize loans in secondary markets through whole-loan sales and securitizations. In 2005, we sold mortgage loans of approximately $435 billion, including securitized home mortgage loans and commercial mortgage loans of approximately $190 billion. The amount of mortgage loans, home equity loans and other consumer loans available to be sold or securitized was approximately $150 billion at December 31, 2005. Core customer deposits have historically provided a sizeable source of relatively stable and low-cost funds. Average core deposits and stockholders’ equity funded 63.2% and 63.1% of average total assets in 2005 and 2004, respectively. The remaining assets were funded by long-term debt, deposits in foreign ofﬁces, short-term borrowings (federal funds purchased, securities sold under repurchase agreements, commercial paper and other short-term borrowings) and trust preferred securities. Short-term borrowings averaged $24.1 billion in 2005 and $26.1 billion in 2004. Long-term debt averaged $79.1 billion in 2005 and $67.9 billion in 2004. We anticipate making capital expenditures of approxi- mately $900 million in 2006 for our stores, relocation and remodeling of Company facilities, and routine replacement of furniture, equipment and servers. We fund expenditures from various sources, including cash ﬂows from operations, retained earnings and borrowings. Liquidity is also available through our ability to raise funds in a variety of domestic and international money and capital markets. We access capital markets for long-term funding by issuing registered debt, private placements and asset-backed secured funding. Rating agencies base their ratings on many quantitative and qualitative factors, including capital adequacy, liquidity, asset quality, business mix and level and quality of earnings. Material changes in these factors could result in a different debt rating; however, a change in debt rating would not cause us to violate any of our debt covenants. In September 2003, Moody’s Investors Service rated Wells Fargo Bank, N.A. as “Aaa,” its highest investment grade, and rated the Company’s senior debt rating as “Aa1.” In July 2005, Dominion Bond Rating Service raised the Company’s senior debt rating to “AA” from “AA(low).” Table 12 provides the credit ratings of the Company and Wells Fargo Bank, N.A. as of December 31, 2005. Table 12: Credit Ratings Wells Fargo & Company Wells Fargo Bank, N.A. Senior Subordinated Commercial Long-term Short-term borrowings debt deposits paper debt Moody’s Standard & Poor’s Fitch, Inc. Dominion Bond Rating Service Aa1 Aa2 AA- AA A+ AA- P-1 A-1+ F1+ Aaa AA AA+ P-1 A-1+ F1+ AA AA(low) R-1(middle) AA(high) R-1(high) On June 29, 2005, the SEC adopted amendments to its rules with respect to the registration, communications and offerings processes under the Securities Act of 1933. The rules, which became effective December 1, 2005, facilitate access to the capital markets by well-established public companies, modernize the existing restrictions on corporate communications during a securities offering and further integrate disclosures under the Securities Act of 1933 and the Securities Exchange Act of 1934. The amended rules provide the most ﬂexibility to “well-known seasoned issuers” (Seasoned Issuers), including the option of automatic effectiveness upon ﬁling of shelf registration statements and relief under the less restrictive communications rules. Seasoned Issuers generally include those companies with a public ﬂoat of common equity of at least $700 million or those companies that have issued at least $1 billion in aggregate principal amount of non-convertible securities, other than common equity, in the last three years. Based on each of these criteria calculated as of December 1, 2005, the Company met the eligibility requirements to qualify as a Seasoned Issuer. PARENT. In July 2005, the Parent’s registration statement with the SEC for issuance of $30 billion in senior and subordinated notes, preferred stock and other securities became effective. During 2005, the Parent issued a total of $16.0 billion of senior notes, including approximately $1.3 billion (denominated in pounds sterling) sold primarily in the United Kingdom. Also, in 2005, the Parent issued $1.5 billion (denominated in Australian dollars) in senior notes under the Parent’s Australian debt issuance program. At December 31, 2005, the Parent’s remaining authorized issuance capacity under its effective registration statements was $24.8 billion. We used the proceeds from securities issued in 2005 for general corporate purposes and expect that the proceeds in the future will also be used for general corporate purposes. In January and February 2006, the Parent issued a total of $3.6 billion in senior notes, including approximately $900 million denominated in pounds sterling. The Parent also issues commercial paper from time to time. 55 WELLS FARGO BANK, N.A. In March 2003, Wells Fargo Bank, N.A. established a $50 billion bank note program under which it may issue up to $20 billion in short-term senior notes outstanding at any time and up to a total of $30 billion in long-term senior notes. Securities are issued under this program as private placements in accordance with Ofﬁce of the Comptroller of the Currency (OCC) regulations. During 2005, Wells Fargo Bank, N.A. issued $2.3 billion in long-term senior notes. At December 31, 2005, the remaining long-term issuance authority was $6.7 billion. Wells Fargo Bank, N.A. also issued $1.5 billion in subordinated debt in 2005. Capital Management We have an active program for managing stockholder capital. We use capital to fund organic growth, acquire banks and other ﬁnancial services companies, pay dividends and repur- chase our shares. Our objective is to produce above-market long-term returns by opportunistically using capital when returns are perceived to be high and issuing/accumulating capital when such costs are perceived to be low. From time to time our Board of Directors authorizes the Company to repurchase shares of our common stock. Although we announce when our Board authorizes share repurchases, we typically do not give any public notice before we repurchase our shares. Various factors determine the amount and timing of our share repurchases, including our capital requirements, the number of shares we expect to issue for acquisitions and employee beneﬁt plans, market conditions (including the trading price of our stock), and legal considerations. These factors can change at any time, and there can be no assurance as to the number of shares we will repurchase or when we will repurchase them. Historically, our policy has been to repurchase shares under the “safe harbor” conditions of Rule 10b-18 of the Exchange Act including a limitation on the daily volume of repurchases. Rule 10b-18 imposes an additional daily volume limitation on share repurchases during a pending merger or acquisition in which shares of our stock will constitute some or all of the consideration. Our management may determine that during a pending stock merger or acquisition when the safe harbor would otherwise be available, it is in the Company’s best interest to repurchase shares in excess of WELLS FARGO FINANCIAL. In November 2003, Wells Fargo Financial Canada Corporation (WFFCC), a wholly-owned Canadian subsidiary of Wells Fargo Financial, Inc. (WFFI), qualiﬁed for distribution with the provincial securities exchanges in Canada $1.5 billion (Canadian) of issuance authority. In December 2004, WFFCC amended its existing shelf registration by adding $2.5 billion (Canadian) of issuance authority. During 2005, WFFCC issued $2.2 billion (Canadian) in senior notes. The remaining issuance capacity for WFFCC of $700 million (Canadian) expired in December 2005. In January 2006, a $7.0 billion (Canadian) shelf registration became effective. In 2005, WFFI entered into a secured borrowing arrangement for $1 billion (U.S.). Under the terms of the arrangement, WFFI pledged auto loans as security for the borrowing. this additional daily volume limitation. In such cases, we intend to repurchase shares in compliance with the other conditions of the safe harbor, including the standing daily volume limitation that applies whether or not there is a pending stock merger or acquisition. In 2005, the Board of Directors authorized the repurchase of up to 75 million additional shares of our outstanding common stock. During 2005, we repurchased approximately 53 million shares of our common stock. At December 31, 2005, the total remaining common stock repurchase authority was approximately 35 million shares. Our potential sources of capital include retained earnings, and issuances of common and preferred stock and subordi- nated debt. In 2005, retained earnings increased $4.1 billion, predominantly as a result of net income of $7.7 billion less dividends of $3.4 billion. In 2005, we issued $1.9 billion of common stock under various employee beneﬁt and director plans and under our dividend reinvestment and direct stock purchase programs. The Company and each of our subsidiary banks are subject to various regulatory capital adequacy requirements administered by the Federal Reserve Board and the OCC. Risk-based capital guidelines establish a risk-adjusted ratio relating capital to different categories of assets and off-balance sheet exposures. At December 31, 2005, the Company and each of our covered subsidiary banks were “well capitalized” under applicable regulatory capital adequacy guidelines. See Note 25 (Regulatory and Agency Capital Requirements) to Financial Statements for additional information. 56 Comparison of 2004 with 2003 Net income in 2004 increased 13% to $7.0 billion from $6.2 billion in 2003. Diluted earnings per common share increased 12% to $4.09 in 2004 from $3.65 in 2003. In addition to incremental investments in new stores, sales- focused team members and technology, 2004 results included $217 million ($.08 per share) of charitable contribution expense for the Wells Fargo Foundation, $44 million ($.02 per share) for a special 401(k) contribution and $19 million ($.01 per share) in integration expense related to the Strong Financial transaction. We also took signiﬁcant actions to reposition our balance sheet in 2004 designed to improve earning asset yields and to reduce long-term debt costs. The extinguishment of high interest rate debt reduced earnings by $174 million ($.06 per share) for 2004. Return on average assets was 1.71% and return on average common equity was 19.56% in 2004, up from 1.64% and 19.36%, respectively, for 2003. Net interest income on a taxable-equivalent basis was $17.3 billion in 2004, compared with $16.1 billion in 2003, an increase of 7%. The increase was primarily due to strong consumer loan growth, especially in mortgage products. The beneﬁt of this growth was partially offset by lower loan yields as new volumes were added below the portfolio average. The net interest margin for 2004 decreased to 4.89% from 5.08% in 2003. The decrease was primarily due to lower investment portfolio yields following maturities and prepayments of higher yielding mortgage-backed securities, and the addition of new consumer and commercial loans with yields below the existing portfolio average. These factors were partially offset by the beneﬁts of balance sheet repositioning actions taken in 2004. Noninterest income was $12.9 billion in 2004, compared with $12.4 billion in 2003, an increase of 4%, driven by growth across our business, with particular strength in trust, investment and IRA fees, card fees, loan fees and gains on equity investments. Mortgage banking noninterest income was $1,860 million in 2004, compared with $2,512 million in 2003. Net servicing income was $1,037 million in 2004, compared with losses of $954 million in 2003. The increase in net servicing income in 2004, compared with 2003, reﬂected a reduction of $934 million in amortization due to an increase in average interest rates and higher gross servicing fees resulting from growth in the servicing portfolio. In addition, to reﬂect the higher value of our MSRs, we reversed $208 million of the valuation allowance in 2004, compared with an impairment provision of $1,092 million in 2003. Net derivative gains on fair value hedges of our MSRs were $554 million and $1,111 million in 2004 and 2003, respectively. Net gains on mortgage loan origination/sales activities were $539 million in 2004, compared with $3,019 million for 2003. Lower gains in 2004 compared with 2003 reﬂected lower origination volume and a decrease in margins, due primarily to the increase in average interest rates and lower consumer demand. Originations during 2004 declined to $298 billion from $470 billion in 2003. Revenue, the sum of net interest income and noninterest income, increased 6% to a record $30.1 billion in 2004 from $28.4 billion in 2003, despite a 37% decrease in mortgage originations as the reﬁnance driven market declined from its exceptional 2003 level. Despite our balance sheet reposition- ing actions in 2004, which reduced 2004 revenue growth by approximately 1 percentage point due to the loss on sale of lower yielding assets, and our signiﬁcant level of investment spending, operating leverage improved during 2004 with revenue growing 6% and noninterest expense up only 2%. For the year, Home Mortgage revenue declined $807 million, or 16%, from $5.2 billion in 2003 to $4.4 billion in 2004. Noninterest expense was $17.6 billion in 2004, compared with $17.2 billion in 2003, an increase of 2%. During 2004, net charge-offs were $1.67 billion, or .62% of average total loans, compared with $1.72 billion, or .81%, during 2003. The provision for credit losses was $1.72 billion in 2004, ﬂat compared with 2003. The allowance for credit losses, which consists of the allowance for loan losses and the reserve for unfunded credit commitments, was $3.95 billion, or 1.37% of total loans, at December 31, 2004, and $3.89 billion, or 1.54%, at December 31, 2003. At December 31, 2004, total nonaccrual loans were $1.36 billion, or .47% of total loans, down from $1.46 billion, or .58%, at December 31, 2003. Foreclosed assets were $212 million at December 31, 2004, compared with $198 million at December 31, 2003. 57 Controls and Procedures Disclosure Controls and Procedures As required by SEC rules, the Company’s management evaluated the effectiveness, as of December 31, 2005, of the Company’s disclosure controls and procedures. The Company’s chief executive ofﬁcer and chief ﬁnancial ofﬁcer participated in the evaluation. Based on this evaluation, the Company’s chief executive ofﬁcer and the chief ﬁnancial ofﬁcer concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2005. Internal Control over Financial Reporting Internal control over ﬁnancial reporting is deﬁned in Rule 13a-15(f) promulgated under the Securities Exchange Act of 1934 as a process designed by, or under the supervision of, the company’s principal executive and principal ﬁnancial ofﬁcers and effected by the company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of ﬁnancial reporting and the preparation of ﬁnancial statements for external purposes in accordance with GAAP and includes those policies and procedures that: • pertain to the maintenance of records that in reasonable detail accurately and fairly reﬂect the transactions and dispositions of assets of the company; • provide reasonable assurance that transactions are recorded as necessary to permit preparation of ﬁnancial statements in accordance with GAAP, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and • provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the ﬁnancial statements. Because of its inherent limitations, internal control over ﬁnancial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. No change occurred during fourth quarter 2005 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over ﬁnancial reporting. Management’s report on internal control over ﬁnancial reporting is set forth below, and should be read with these limitations in mind. Management’s Report on Internal Control over Financial Reporting The Company’s management is responsible for establishing and maintaining adequate internal control over ﬁnancial reporting for the Company. Management assessed the effectiveness of the Company’s internal control over ﬁnancial reporting as of December 31, 2005, using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control – Integrated Framework. Based on this assessment, management concluded that as of December 31, 2005, the Company’s internal control over ﬁnancial reporting was effective. KPMG LLP, the independent registered public accounting ﬁrm that audited the Company’s ﬁnancial statements included in this Annual Report, issued an audit report on management’s assessment of the Company’s internal control over ﬁnancial reporting. KPMG’s audit report appears on the following page. 58 Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders Wells Fargo & Company: We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that Wells Fargo & Company and Subsidiaries (“the Company”) maintained effective internal control over ﬁnancial reporting as of December 31, 2005, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over ﬁnancial reporting and for its assessment of the effectiveness of internal control over ﬁnancial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over ﬁnancial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over ﬁnancial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over ﬁnancial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over ﬁnancial reporting is a process designed to provide reasonable assurance regarding the reliability of ﬁnancial reporting and the preparation of ﬁnancial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over ﬁnancial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reﬂect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of ﬁnancial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the ﬁnancial statements. Because of its inherent limitations, internal control over ﬁnancial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management’s assessment that the Company maintained effective internal control over ﬁnancial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control – Integrated Framework issued by COSO. Also in our opinion, the Company maintained, in all material respects, effective internal control over ﬁnancial reporting as of December 31, 2005, based on criteria established in Internal Control – Integrated Framework issued by COSO. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of the Company as of December 31, 2005 and 2004, and the related consolidated statements of income, changes in stockholders’ equity and comprehensive income, and cash ﬂows for each of the years in the three-year period ended December 31, 2005, and our report dated February 21, 2006, expressed an unqualiﬁed opinion on those consolidated ﬁnancial statements. San Francisco, California February 21, 2006 59 Financial Statements Wells Fargo & Company and Subsidiaries Consolidated Statement of Income (in millions, except per share amounts) INTEREST INCOME Trading assets Securities available for sale Mortgages held for sale Loans held for sale Loans Other interest income Total interest income INTEREST EXPENSE Deposits Short-term borrowings Long-term debt Guaranteed preferred beneﬁcial interests in Company’s subordinated debentures Total interest expense NET INTEREST INCOME Provision for credit losses Net interest income after provision for credit losses NONINTEREST INCOME Service charges on deposit accounts Trust and investment fees Card fees Other fees Mortgage banking Operating leases Insurance Net gains (losses) on debt securities available for sale Net gains from equity investments Other Total noninterest income NONINTEREST EXPENSE Salaries Incentive compensation Employee beneﬁts Equipment Net occupancy Operating leases Other Total noninterest expense INCOME BEFORE INCOME TAX EXPENSE Income tax expense NET INCOME EARNINGS PER COMMON SHARE DILUTED EARNINGS PER COMMON SHARE DIVIDENDS DECLARED PER COMMON SHARE Average common shares outstanding Diluted average common shares outstanding The accompanying notes are an integral part of these statements. 60 2005 $ 190 1,921 2,213 146 21,260 232 25,962 3,848 744 2,866 — 7,458 18,504 2,383 16,121 2,512 2,436 1,458 1,929 2,422 812 1,215 (120) 511 1,270 14,445 6,215 2,366 1,874 1,267 1,412 635 5,249 19,018 11,548 3,877 $ 7,671 $ $ $ 4.55 4.50 2.00 1,686.3 1,705.5 Year ended December 31, 2003 2004 $ 145 1,883 1,737 292 16,781 129 20,967 1,827 353 1,637 — 3,817 17,150 1,717 15,433 2,417 2,116 1,230 1,779 1,860 836 1,193 (15) 394 1,099 12,909 5,393 1,807 1,724 1,236 1,208 633 5,572 17,573 10,769 3,755 $ 7,014 $ $ $ 4.15 4.09 1.86 1,692.2 1,713.4 $ 156 1,816 3,136 251 13,937 122 19,418 1,613 322 1,355 121 3,411 16,007 1,722 14,285 2,297 1,937 1,079 1,560 2,512 937 1,071 4 55 930 12,382 4,832 2,054 1,560 1,246 1,177 702 5,619 17,190 9,477 3,275 $ 6,202 $ $ $ 3.69 3.65 1.50 1,681.1 1,697.5 Wells Fargo & Company and Subsidiaries Consolidated Balance Sheet (in millions, except shares) ASSETS Cash and due from banks Federal funds sold, securities purchased under resale agreements and other short-term investments Trading assets Securities available for sale Mortgages held for sale Loans held for sale Loans Allowance for loan losses Net loans Mortgage servicing rights, net Premises and equipment, net Goodwill Other assets Total assets LIABILITIES Noninterest-bearing deposits Interest-bearing deposits Total deposits Short-term borrowings Accrued expenses and other liabilities Long-term debt Total liabilities STOCKHOLDERS’ EQUITY Preferred stock Common stock – $12/3 par value, authorized 6,000,000,000 shares; issued 1,736,381,025 shares Additional paid-in capital Retained earnings Cumulative other comprehensive income Treasury stock – 58,797,993 shares and 41,789,388 shares Unearned ESOP shares Total stockholders’ equity Total liabilities and stockholders’ equity The accompanying notes are an integral part of these statements. December 31, 2004 2005 $ 15,397 $ 12,903 5,306 10,905 41,834 40,534 612 310,837 (3,871) 306,966 12,511 4,417 10,787 32,472 $481,741 $ 87,712 226,738 314,450 23,892 23,071 79,668 441,081 5,020 9,000 33,717 29,723 8,739 287,586 (3,762) 283,824 7,901 3,850 10,681 22,491 $427,849 $ 81,082 193,776 274,858 21,962 19,583 73,580 389,983 325 270 2,894 9,934 30,580 665 (3,390) (348) 40,660 $481,741 2,894 9,806 26,482 950 (2,247) (289) 37,866 $427,849 61 Wells Fargo & Company and Subsidiaries Consolidated Statement of Changes in Stockholders’ Equity and Comprehensive Income (in millions, except shares) BALANCE DECEMBER 31, 2002 Comprehensive income Net income – 2003 Other comprehensive income, net of tax: Translation adjustments Net unrealized losses on securities available for sale and other retained interests Net unrealized gains on derivatives and hedging activities Total comprehensive income Common stock issued Common stock issued for acquisitions Common stock repurchased Preferred stock (260,200) issued to ESOP Preferred stock released to ESOP Preferred stock (223,660) converted to common shares Preferred stock (1,460,000) redeemed Preferred stock dividends Common stock dividends Change in Rabbi trust assets and similar arrangements (classiﬁed as treasury stock) Other, net Net change BALANCE DECEMBER 31, 2003 Comprehensive income Net income – 2004 Other comprehensive income, net of tax: Translation adjustments Net unrealized losses on securities available for sale and other retained interests Net unrealized gains on derivatives and hedging activities Total comprehensive income Common stock issued Common stock issued for acquisitions Common stock repurchased Preferred stock (321,000) issued to ESOP Preferred stock released to ESOP Preferred stock (265,537) converted to common shares Common stock dividends Change in Rabbi trust assets and similar arrangements (classiﬁed as treasury stock) Other, net Net change BALANCE DECEMBER 31, 2004 Comprehensive income Net income – 2005 Other comprehensive income, net of tax: Translation adjustments Net unrealized losses on securities available for sale and other retained interests Net unrealized gains on derivatives and hedging activities Total comprehensive income Common stock issued Common stock issued for acquisitions Common stock repurchased Preferred stock (363,000) issued to ESOP Preferred stock released to ESOP Preferred stock (307,100) converted to common shares Common stock dividends Other, net Net change BALANCE DECEMBER 31, 2005 Number of common shares Preferred stock Common Additional paid-in capital stock Retained earnings Cumulative other comprehensive income Treasury Unearned ESOP shares stock Total stock- holders’ equity 1,685,906,507 $ 251 $ 2,894 $ 9,498 $ 19,355 $ 976 $ (2,465) $(190) $ 30,319 6,202 (190) (3) (2,527) 63 66 19 (16) 13 26 (117) 53 1,221 585 (1,482) 211 (279) 240 26,063,731 12,399,597 (30,779,500) 4,519,039 260 (224) (73) ___________ 12,202,867 ____ (37) ______ — ______ 145 5 3,487 _____ (38) 97 ______ 632 _____ (39) 6,202 26 (117) 53 6,164 1,094 651 (1,482) — 224 — (73) (3) (2,527) 97 5 4,150 1,698,109,374 214 2,894 9,643 22,842 938 (1,833) (229) 34,469 7,014 (206) (3,150) 129 1 23 (19) 29 29,969,653 153,482 (38,172,556) 321 4,531,684 (265) ______________ (3,517,737) 1,694,591,637 _____ 56 270 _______ — _______ 163 (18) 3,640 2,894 9,806 26,482 12 (22) 22 ______ 12 950 5 (298) 8 7,014 12 (22) 22 7,026 1,446 9 (2,188) — 265 — (3,150) 7 (18) 3,397 1,523 8 (2,188) 236 (344) 284 7 _________ (414) ______ (60) (2,247) (289) 37,866 7,671 5 (298) 8 7,386 1,510 122 (3,159) — 307 — (3,375) 3 2,794 1,617 110 (3,159) 286 (387) 328 7,671 (198) 91 12 25 (21) 21 28,764,493 1,954,502 (52,798,864) 362 5,071,264 (307) _____________ (17,008,605) 1,677,583,032 _____ 55 $325 ______ — ______ 128 (3,375) ________ 4,098 _____ (285) 3 (1,143) _____ (59) $2,894 $9,934 $30,580 $ 665 $(3,390) $(348) $40,660 The accompanying notes are an integral part of these statements. 62 Net cash provided (used) by operating activities (9,333) 6,485 Wells Fargo & Company and Subsidiaries Consolidated Statement of Cash Flows (in millions) Cash ﬂows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Provision for credit losses Provision (reversal of provision) for mortgage servicing rights in excess of fair value Depreciation and amortization Net gains on securities available for sale Net gains on mortgage loan origination/sales activities Other net losses (gains) Preferred shares released to ESOP Net decrease (increase) in trading assets Net increase in deferred income taxes Net increase in accrued interest receivable Net increase (decrease) in accrued interest payable Originations of mortgages held for sale Proceeds from sales of mortgages originated for sale Principal collected on mortgages originated for sale Net decrease (increase) in loans originated for sale Other assets, net Other accrued expenses and liabilities, net Cash ﬂows from investing activities: Securities available for sale: Sales proceeds Prepayments and maturities Purchases Net cash acquired from (paid for) acquisitions Increase in banking subsidiaries’ loan originations, net of collections Proceeds from sales (including participations) of loans by banking subsidiaries Purchases (including participations) of loans by banking subsidiaries Principal collected on nonbank entities’ loans Loans originated by nonbank entities Purchases of loans by nonbank entities Proceeds from sales of foreclosed assets Net increase in federal funds sold, securities purchased under resale agreements and other short-term investments Net increase in mortgage servicing rights Other, net Net cash used by investing activities Cash ﬂows from ﬁnancing activities: Net increase in deposits Net increase (decrease) in short-term borrowings Proceeds from issuance of long-term debt Long-term debt repayment Proceeds from issuance of guaranteed preferred beneﬁcial interests in Company’s subordinated debentures Proceeds from issuance of common stock Preferred stock redeemed Common stock repurchased Cash dividends paid on preferred and common stock Other, net Net cash provided by ﬁnancing activities Net change in cash and due from banks Cash and due from banks at beginning of year Cash and due from banks at end of year Supplemental disclosures of cash ﬂow information: Cash paid during the year for: Interest Income taxes 2005 Year ended December 31, 2004 2003 $ 7,671 $ 7,014 $ 6,202 2,383 (378) 4,161 (40) (1,085) (75) 307 (1,905) 813 (796) 311 (230,897) 214,740 1,426 683 (10,237) 3,585 1,717 (208) 3,449 (60) (539) 9 265 (81) 432 (196) 47 (221,978) 217,272 1,409 (1,331) (2,468) 1,732 19,059 6,972 (28,634) 66 (42,309) 42,239 (8,853) 22,822 (33,675) — 444 (281) (4,595) (3,324) (30,069) 38,961 1,878 26,473 (18,576) — 1,367 — (3,159) (3,375) (1,673) 41,896 2,494 12,903 $ 15,397 6,322 8,823 (16,583) (331) (33,800) 14,540 (5,877) 17,996 (27,751) — 419 (1,287) (1,389) (516) (39,434) 27,327 (2,697) 29,394 (19,639) — 1,271 — (2,188) (3,150) (13) 30,305 (2,644) 15,547 $ 12,903 1,722 1,092 4,305 (62) (3,019) (11) 224 1,248 1,698 (148) (63) (382,335) 404,207 3,136 (832) (5,099) (1,070) 31,195 7,357 13,152 (25,131) (822) (36,235) 1,590 (15,087) 17,638 (21,792) (3,682) 264 (208) (3,875) 3,852 (62,979) 28,643 (8,901) 29,490 (17,931) 700 944 (73) (1,482) (2,530) 651 29,511 (2,273) 17,820 $ 15,547 $ 7,769 3,584 $ 3,864 2,326 $ 3,348 2,713 Noncash investing and ﬁnancing activities: Net transfers from loans to mortgages held for sale Net transfers from loans held for sale to loans Transfers from loans to foreclosed assets Transfers from mortgages held for sale to securities available for sale 41,270 7,444 567 5,490 11,225 — 603 — The accompanying notes are an integral part of these statements. 368 — 411 — 63 Notes to Financial Statements Note 1: Summary of Signiﬁcant Accounting Policies Trading Assets Trading assets are primarily securities, including corporate debt, U.S. government agency obligations and other securities that we acquire for short-term appreciation or other trading purposes, and the fair value of derivatives held for customer accommodation purposes or proprietary trading. Trading assets are carried at fair value, with realized and unrealized gains and losses recorded in noninterest income. Securities SECURITIES AVAILABLE FOR SALE Debt securities that we might not hold until maturity and marketable equity securities are classiﬁed as securities available for sale and reported at esti- mated fair value. Unrealized gains and losses, after applicable taxes, are reported in cumulative other comprehensive income. We use current quotations, where available, to estimate the fair value of these securities. Where current quotations are not available, we estimate fair value based on the present value of future cash ﬂows, adjusted for the credit rating of the securities, prepayment assumptions and other factors. We reduce the asset value when we consider the declines in the value of debt securities and marketable equity securi- ties to be other-than-temporary and record the estimated loss in noninterest income. The initial indicator of impairment for both debt and marketable equity securities is a sustained decline in market price below the amount recorded for that investment. We consider the length of time and the extent to which market value has been less than cost, any recent events speciﬁc to the issuer and economic conditions of its industry and our investment horizon in relationship to an anticipated near-term recovery in the stock or bond price, if any. For marketable equity securities, we also consider the issuer’s ﬁnancial condition, capital strength, and near-term prospects. For debt securities we also consider: • the cause of the price decline – general level of interest rates and industry and issuer-speciﬁc factors; • the issuer’s ﬁnancial condition, near term prospects and current ability to make future payments in a timely manner; • the issuer’s ability to service debt; and • any change in agencies’ ratings at evaluation date from acquisition date and any likely imminent action. Wells Fargo & Company is a diversiﬁed ﬁnancial services company. We provide banking, insurance, investments, mortgage banking and consumer ﬁnance through banking stores, the internet and other distribution channels to consumers, businesses and institutions in all 50 states of the U.S. and in other countries. In this Annual Report, Wells Fargo & Company and Subsidiaries (consolidated) are called the Company. Wells Fargo & Company (the Parent) is a ﬁnancial holding company and a bank holding company. Our accounting and reporting policies conform with U.S. generally accepted accounting principles (GAAP) and practices in the ﬁnancial services industry. To prepare the ﬁnancial statements in conformity with GAAP, management must make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the ﬁnancial statements and income and expenses during the reporting period. Management has made signiﬁcant estimates in several areas, including the allowance for credit losses (Note 6), valuing mortgage servicing rights (Notes 20 and 21) and pension accounting (Note 15). Actual results could differ from those estimates. The following is a description of our signiﬁcant accounting policies. Consolidation Our consolidated ﬁnancial statements include the accounts of the Parent and our majority-owned subsidiaries and vari- able interest entities (VIEs) (deﬁned below) in which we are the primary beneﬁciary. Signiﬁcant intercompany accounts and transactions are eliminated in consolidation. If we own at least 20% of an entity, we generally account for the investment using the equity method. If we own less than 20% of an entity, we generally carry the investment at cost, except marketable equity securities, which we carry at fair value with changes in fair value included in other compre- hensive income. Assets accounted for under the equity or cost method are included in other assets. We are a variable interest holder in certain special pur- pose entities in which we do not have a controlling ﬁnancial interest or do not have enough equity at risk for the entity to ﬁnance its activities without additional subordinated ﬁnan- cial support from other parties. Our variable interest arises from contractual, ownership or other monetary interests in the entity, which change with ﬂuctuations in the entity’s net asset value. We consolidate a VIE if we are the primary ben- eﬁciary because we will absorb a majority of the entity’s expected losses, receive a majority of the entity’s expected residual returns, or both. 64 We manage these investments within capital risk limits approved by management and the Board of Directors and monitored by the Corporate Asset/Liability Management Committee. We recognize realized gains and losses on the sale of these securities in noninterest income using the speciﬁc identiﬁcation method. Unamortized premiums and discounts are recognized in interest income over the contractual life of the security using the interest method. As principal repayments are received on securities (i.e., primarily mortgage-backed securities) a pro-rata portion of the unamortized premium or discount is recognized in interest income. NONMARKETABLE EQUITY SECURITIES Nonmarketable equity securities include venture capital equity securities that are not publicly traded and securities acquired for various pur- poses, such as to meet regulatory requirements (for example, Federal Reserve Bank and Federal Home Loan Bank stock). We review these assets at least quarterly for possible other- than-temporary impairment. Our review typically includes an analysis of the facts and circumstances of each invest- ment, the expectations for the investment’s cash ﬂows and capital needs, the viability of its business model and our exit strategy. These securities are accounted for under the cost or equity method and are included in other assets. We reduce the asset value when we consider declines in value to be other-than-temporary. We recognize the estimated loss as a loss from equity investments in noninterest income. Mortgages Held for Sale Mortgages held for sale include residential mortgages that were originated in accordance with secondary market pricing and underwriting standards and certain mortgages originated initially for investment and not underwritten to secondary market standards, and are stated at the lower of cost or market value. Gains and losses on loan sales (sales proceeds minus carrying value) are recorded in noninterest income. Direct loan origination costs and fees are deferred at origination of the loan. These deferred costs and fees are recognized in mortgage banking noninterest income upon sale of the loan. Loans Held for Sale Loans held for sale are carried at the lower of cost or market value. Gains and losses on loan sales (sales proceeds minus carrying value) are recorded in noninterest income. Direct loan origination costs and fees are deferred at origination of the loan. These deferred costs and fees are recognized in noninterest income upon the sale of the loan. Loans Loans are reported at their outstanding principal balances net of any unearned income, charge-offs, unamortized deferred fees and costs on originated loans and premiums or discounts on purchased loans, except for certain purchased loans, which are recorded at fair value on their purchase date. Unearned income, deferred fees and costs, and discounts and premiums are amortized to income over the contractual life of the loan using the interest method. Lease ﬁnancing assets include aggregate lease rentals, net of related unearned income, which includes deferred investment tax credits, and related nonrecourse debt. Leasing income is recognized as a constant percentage of outstanding lease ﬁnancing balances over the lease terms. Loan commitment fees are generally deferred and amor- tized into noninterest income on a straight-line basis over the commitment period. From time to time, we pledge loans, primarily 1-4 family mortgage loans, to secure borrowings from the Federal Home Loan Bank. NONACCRUAL LOANS We generally place loans on nonaccrual status when: • the full and timely collection of interest or principal becomes uncertain; • they are 90 days (120 days with respect to real estate 1-4 family ﬁrst and junior lien mortgages) past due for interest or principal (unless both well-secured and in the process of collection); or • part of the principal balance has been charged off. Generally, consumer loans not secured by real estate are placed on nonaccrual status only when part of the principal has been charged off. These loans are entirely charged off when deemed uncollectible or when they reach a deﬁned number of days past due based on loan product, industry practice, country, terms and other factors. When we place a loan on nonaccrual status, we reverse the accrued and unpaid interest receivable against interest income and account for the loan on the cash or cost recovery method, until it qualiﬁes for return to accrual status. Generally, we return a loan to accrual status when (a) all delinquent interest and principal becomes current under the terms of the loan agreement or (b) the loan is both well-secured and in the process of collection and collectibility is no longer doubtful, after a period of demonstrated performance. IMPAIRED LOANS We assess, account for and disclose as impaired certain nonaccrual commercial and commercial real estate loans that are over $3 million. We consider a loan to be impaired when, based on current information and events, we will probably not be able to collect all amounts due according to the loan contract, including scheduled interest payments. When we identify a loan as impaired, we measure the impairment based on the present value of expected future cash ﬂows, discounted at the loan’s effective interest rate, except when the sole (remaining) source of repayment for the loan is the operation or liquidation of the collateral. In these cases we use an observable market price or the current fair value of the collateral, less selling costs, instead of dis- counted cash ﬂows. If we determine that the value of the impaired loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), we recognize impairment through an allocated reserve or a charge-off to the allowance. 65 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. Our determination of the allowance, and the resulting provision, is based on judgments and assumptions, including: • general economic conditions; • loan portfolio composition; • loan loss experience; • management’s evaluation of credit risk relating to pools of loans and individual borrowers; • sensitivity analysis and expected loss models; and • observations from our internal auditors, internal loan review staff or banking regulators. Transfers and Servicing of Financial Assets We account for a transfer of ﬁnancial assets as a sale when we surrender control of the transferred assets. Servicing rights and other retained interests in the sold assets are recorded by allocating the previously recorded investment between the assets sold and the interest retained based on their relative fair values at the date of transfer. We determine the fair values of servicing rights and other retained interests at the date of transfer using the present value of estimated future cash ﬂows, using assumptions that market partici- pants use in their estimates of values. We use quoted market prices when available to determine the value of other retained interests. We recognize the rights to service mortgage loans for oth- ers, or mortgage servicing rights (MSRs), as assets whether we purchase the servicing rights or sell or securitize loans we originate and retain servicing rights. MSRs are amortized in proportion to, and over the period of, estimated net servicing income. The amortization of MSRs is analyzed monthly and is adjusted to reﬂect changes in prepayment speeds, as well as other factors. To determine the fair value of MSRs, we use a valuation model that calculates the present value of estimated future net servicing income. We use assumptions in the valuation model that market participants use in estimating future net servicing income, including estimates of prepayment speeds, discount rate, cost to service, escrow account earnings, con- tractual servicing fee income, ancillary income and late fees. At the end of each quarter, we evaluate MSRs for possible impairment based on the difference between the carrying amount and current fair value, in accordance with Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (FAS 140). To evaluate and measure impairment we stratify the portfolio based on certain risk characteristics, including loan type and note rate. If temporary impairment exists, we establish a valuation allowance through a charge to income for those risk stratiﬁcations with an excess of amortized cost over the current fair value. If we later determine that all or a portion of the temporary impairment no longer exists for a particular risk stratiﬁcation, we will reduce the valuation allowance through an increase to income. Under our policy, we evaluate other-than-temporary impairment of MSRs by considering both historical and projected trends in interest rates, pay off activity and whether the impairment could be recovered through interest rate increases. We recognize a direct write-down when we determine that the recoverability of a recorded valuation allowance is remote. A direct write-down permanently reduces the carrying value of the MSRs, while a valuation allowance (temporary impairment) can be reversed. Premises and Equipment Premises and equipment are carried at cost less accumulated depreciation and amortization. Capital leases are included in premises and equipment at the capitalized amount less accumulated amortization. We primarily use the straight-line method of depreciation and amortization. Estimated useful lives range up to 40 years for buildings, up to 10 years for furniture and equipment, and the shorter of the estimated useful life or lease term for leasehold improvements. We amortize capitalized leased assets on a straight-line basis over the lives of the respective leases. Goodwill and Identifiable Intangible Assets Goodwill is recorded when the purchase price is higher than the fair value of net assets acquired in business combinations under the purchase method of accounting. We assess goodwill for impairment annually, and more frequently in certain circumstances. We assess goodwill for impairment on a reporting unit level by applying a fair- value-based test using discounted estimated future net cash ﬂows. Impairment exists when the carrying amount of the goodwill exceeds its implied fair value. We recognize impair- ment losses as a charge to noninterest expense (unless related to discontinued operations) and an adjustment to the carry- ing value of the goodwill asset. Subsequent reversals of goodwill impairment are prohibited. We amortize core deposit intangibles on an accelerated basis based on useful lives of 10 to 15 years. We review core deposit intangibles for impairment whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. Impairment is indicated if the sum of undiscounted estimated future net cash flows is less than the carrying value of the asset. Impairment is permanently recognized by writing down the asset to the extent that the carrying value exceeds the estimated fair value. 66 Operating Lease Assets Operating lease rental income for leased assets, generally automobiles, is recognized in other income on a straight-line basis over the lease term. Related depreciation expense is recorded on a straight-line basis over the life of the lease, taking into account the estimated residual value of the leased asset. On a periodic basis, leased assets are reviewed for impairment. Impairment loss is recognized if the carrying amount of leased assets exceeds fair value and is not recover- able. The carrying amount of leased assets is not recoverable if it exceeds the sum of the undiscounted cash ﬂows expected to result from the lease payments and the estimated residual value upon the eventual disposition of the equipment. Auto lease receivables are written off when 120 days past due. Pension Accounting We account for our deﬁned beneﬁt pension plans using an actuarial model required by FAS 87, Employers’ Accounting for Pensions. This model allocates pension costs over the service period of employees in the plan. The underlying principle is that employees render service ratably over this period and, therefore, the income statement effects of pensions should follow a similar pattern. One of the principal components of the net periodic pension calculation is the expected long-term rate of return on plan assets. The use of an expected long-term rate of return on plan assets may cause us to recognize pension income returns that are greater or less than the actual returns of plan assets in any given year. The expected long-term rate of return is designed to approximate the actual long-term rate of return over time and is not expected to change signiﬁcantly. Therefore, the pattern of income/expense recognition should closely match the stable pattern of services provided by our employees over the life of our pension obligation. To determine if the expected rate of return is reasonable, we consider such factors as (1) the actual return earned on plan assets, (2) historical rates of return on the various asset classes in the plan portfolio, (3) projections of returns on various asset classes, and (4) current/prospective capital market conditions and economic forecasts. Differences in each year, if any, between expected and actual returns are included in our unrecognized net actuarial gain or loss amount. We generally amortize any unrecognized net actuarial gain or loss in excess of a 5% corridor (as deﬁned in FAS 87) in net periodic pension calculations over the next ﬁve years. We use a discount rate to determine the present value of our future beneﬁt obligations. The discount rate reﬂects the rates available at the measurement date on long-term high-quality ﬁxed-income debt instruments and is reset annually on the measurement date (November 30). Income Taxes We ﬁle a consolidated federal income tax return and, in certain states, combined state tax returns. We determine deferred income tax assets and liabilities 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 recognizes enacted changes in tax rates and laws. Deferred tax assets are recognized subject to manage- ment judgment that realization is more likely than not. Foreign taxes paid are generally applied as credits to reduce federal income taxes payable. Stock-Based Compensation We have several stock-based employee compensation plans, which are described more fully in Note 14. As permitted by FAS 123, Accounting for Stock-Based Compensation, we have elected to apply the intrinsic value method of Accounting Principles Board Opinion 25, Accounting for Stock Issued to Employees (APB 25), in accounting for stock-based employee compensation plans through December 31, 2005. Pro forma net income and earnings per common share information is provided below, as if we accounted for employee stock option plans under the fair value method of FAS 123. On December 16, 2004, the FASB issued FAS 123 (revised 2004), Share-Based Payment (FAS 123R), which replaced FAS 123 and superceded APB 25. We adopted FAS 123R on January 1, 2006, which requires us to measure the cost of employee services received in exchange for an award of equity instruments, such as stock options or restricted stock, based on the fair value of the award on the grant date. This cost must be recognized in the income statement over the vesting period of the award. (in millions, except per share amounts) Year ended December 31, 2003 2004 2005 Net income, as reported $7,671 $7,014 $6,202 Add: Stock-based employee compensation expense included in reported net income, net of tax Less: Total stock-based employee compensation expense under the fair value method for all awards, net of tax Net income, pro forma Earnings per common share As reported Pro forma Diluted earnings per common share As reported Pro forma 1 2 3 (188) $7,484 (275) $6,741 (198) $6,007 $ 4.55 4.44 $ 4.50 4.38 $ 4.15 3.99 $ 4.09 3.93 $ 3.69 3.57 $ 3.65 3.53 67 Stock options granted in each of our February 2005 and February 2004 annual grants, under our Long-Term Incentive Compensation Plan (the Plan), fully vested upon grant, resulting in full recognition of stock-based compensa- tion expense for both grants in the year of the grant under the fair value method in the table on the previous page. Stock options granted in our 2003, 2002 and 2001 annual grants under the Plan vest over a three-year period, and expense reﬂected in the table for these grants is recognized over the vesting period. Earnings Per Common Share We present earnings per common share and diluted earnings per common share. We compute earnings per common share by dividing net income (after deducting dividends on preferred stock) by the average number of common shares outstanding during the year. We compute diluted earnings per common share by dividing net income (after deducting dividends on preferred stock) by the average number of common shares outstanding during the year, plus the effect of common stock equivalents (for example, stock options, restricted share rights and convertible debentures) that are dilutive. Derivatives and Hedging Activities We recognize all derivatives on the balance sheet at fair value. On the date we enter into a derivative contract, we designate the derivative as (1) a hedge of the fair value of a recognized asset or liability (“fair value” hedge), (2) a hedge of a forecasted transaction or of the variability of cash ﬂows to be received or paid related to a recognized asset or liability (“cash ﬂow” hedge) or (3) held for trading, customer accommodation or for risk management not qualifying for hedge accounting (“free-standing derivative”). For a fair value hedge, we record changes in the fair value of the derivative and, to the extent that it is effective, changes in the fair value of the hedged asset or liability attributable to the hedged risk, in current period earnings in the same ﬁnancial statement category as the hedged item. For a cash ﬂow hedge, we record changes in the fair value of the derivative to the extent that it is effective in other compre- hensive income. We subsequently reclassify these changes in fair value to net income in the same period(s) that the hedged transaction affects net income in the same ﬁnancial statement category as the hedged item. For free-standing derivatives, we report changes in the fair values in current period noninterest income. We formally document at inception the relationship between hedging instruments and hedged items, our risk management objective, strategy and our evaluation of effec- tiveness for our hedge transactions. This includes linking all derivatives designated as fair value or cash ﬂow hedges to speciﬁc assets and liabilities on the balance sheet or to speciﬁc forecasted transactions. Periodically, as required, we 68 also formally assess whether the derivative we designated in each hedging relationship is expected to be and has been highly effective in offsetting changes in fair values or cash ﬂows of the hedged item using either the dollar offset or the regression analysis method. If we determine that a derivative is not highly effective as a hedge, we discontinue hedge accounting. We discontinue hedge accounting prospectively when (1) a derivative is no longer highly effective in offsetting changes in the fair value or cash ﬂows of a hedged item, (2) a derivative expires or is sold, terminated, or exercised, (3) a derivative is dedesignated as a hedge, because it is unlikely that a forecasted transaction will occur, or (4) we determine that designation of a derivative as a hedge is no longer appropriate. When we discontinue hedge accounting because a deriva- tive no longer qualiﬁes as an effective fair value hedge, we continue to carry the derivative on the balance sheet at its fair value with changes in fair value included in earnings, and no longer adjust the previously hedged asset or liability for changes in fair value. Previous adjustments to the hedged item are accounted for in the same manner as other compo- nents of the carrying amount of the asset or liability. When we discontinue hedge accounting because it is probable that a forecasted transaction will not occur, we continue to carry the derivative on the balance sheet at its fair value with changes in fair value included in earnings, and immediately recognize gains and losses that were accumulated in other comprehensive income in earnings. When we discontinue hedge accounting because the hedg- ing instrument is sold, terminated, or no longer designated (dedesignated), the amount reported in other comprehensive income up to the date of sale, termination or dedesignation continues to be reported in other comprehensive income until the forecasted transaction affects earnings. In all other situations in which we discontinue hedge accounting, the derivative will be carried at its fair value on the balance sheet, with changes in its fair value recognized in current period earnings. We occasionally purchase or originate ﬁnancial instru- ments that contain an embedded derivative. At inception of the ﬁnancial instrument, we assess (1) if the economic characteristics of the embedded derivative are clearly and closely related to the economic characteristics of the ﬁnancial instrument (host contract), (2) if the ﬁnancial instrument that embodies both the embedded derivative and the host contract is measured at fair value with changes in fair value reported in earnings, or (3) if a separate instrument with the same terms as the embedded instrument would meet the deﬁnition of a derivative. If the embedded derivative does not meet any of these conditions, we separate it from the host contract and carry it at fair value with changes recorded in current period earnings. Note 2: Business Combinations We regularly explore opportunities to acquire ﬁnancial services companies and businesses. Generally, we do not make a public announcement about an acquisition opportunity until a deﬁnitive agreement has been signed. Effective December 31, 2004, we completed the acquisition of $29 billion in assets under management, consisting of $24 billion in mutual fund assets and $5 billion in institutional investment accounts, from Strong Financial Corporation. Other business combinations completed in 2005, 2004 and 2003 are presented below. (in millions) 2005 Certain branches of PlainsCapital Bank, Amarillo, Texas First Community Capital Corporation, Houston, Texas Other (1) 2004 Other (2) 2003 Certain assets of Telmark, LLC, Syracuse, New York Paciﬁc Northwest Bancorp, Seattle, Washington Two Rivers Corporation, Grand Junction, Colorado Other (3) At December 31, 2005, we had three pending business combinations with total assets of approximately $278 million. We expect to complete these transactions by second quarter 2006. For information on contingent consideration related to acquisitions, which is considered to be a guarantee, see Note 24. Date July 22 July 31 Various Various February 28 October 31 October 31 Various (1) Consists of 8 acquisitions of insurance brokerage and lockbox processing businesses. (2) Consists of 13 acquisitions of insurance brokerage and payroll services businesses. (3) Consists of 14 acquisitions of asset management, commercial real estate brokerage, bankruptcy and insurance brokerage businesses. Assets $ 190 644 40 $ 874 $ 74 $ 660 3,245 74 136 $ 4,115 69 Note 3: Cash, Loan and Dividend Restrictions Federal Reserve Board regulations require that each of our subsidiary banks maintain reserve balances on deposits with the Federal Reserve Banks. The average required reserve balance was $1.4 billion in 2005 and $1.2 billion in 2004. Federal law restricts the amount and the terms of both credit and non-credit transactions between a bank and its nonbank afﬁliates. They may not exceed 10% of the bank’s capital and surplus (which for this purpose represents Tier 1 and Tier 2 capital, as calculated under the risk-based capital guidelines, plus the balance of the allowance for credit losses excluded from Tier 2 capital) with any single nonbank afﬁli- ate and 20% of the bank’s capital and surplus with all its nonbank afﬁliates. Transactions that are extensions of credit may require collateral to be held to provide added security to the bank. (For further discussion of risk-based capital, see Note 25.) Dividends paid by our subsidiary banks are subject to various federal and state regulatory limitations. Dividends that may be paid by a national bank without the express approval of the Ofﬁce of the Comptroller of the Currency (OCC) are limited to that bank’s retained net proﬁts for the preceding two calendar years plus retained net proﬁts up to the date of any dividend declaration in the current calendar year. Retained net proﬁts, as deﬁned by the OCC, consist of net income less dividends declared during the period. We also have state-chartered subsidiary banks that are subject to state regulations that limit dividends. Under those provi- sions, our national and state-chartered subsidiary banks could have declared additional dividends of $1,185 million at December 31, 2005, without obtaining prior regulatory approval. Our nonbank subsidiaries are also limited by cer- tain federal and state statutory provisions and regulations covering the amount of dividends that may be paid in any given year. Based on retained earnings at year-end 2005, our nonbank subsidiaries could have declared additional dividends of $2,411 million at December 31, 2005, without obtaining prior approval. Note 4: Federal Funds Sold, Securities Purchased Under Resale Agreements and Other Short-Term Investments The table to the right provides the detail of federal funds sold, securities purchased under resale agreements and other short-term investments. (in millions) Federal funds sold and securities purchased under resale agreements Interest-earning deposits Other short-term investments Total December 31, 2004 2005 $3,789 847 670 $5,306 $3,009 1,397 614 $5,020 70 Note 5: Securities Available for Sale The following table provides the cost and fair value for the major categories of securities available for sale carried at fair value. There were no securities classiﬁed as held to maturity as of the periods presented. (in millions) Securities of U.S. Treasury and federal agencies Securities of U.S. states and political subdivisions Mortgage-backed securities: Federal agencies Private collateralized mortgage obligations (1) Total mortgage-backed securities Other Total debt securities Marketable equity securities Total (2) Cost $ 845 3,048 25,304 6,628 31,932 4,518 40,343 558 $40,901 December 31, 2004 Fair value 2005 Fair value Cost Unrealized gross gains Unrealized gross losses Unrealized Unrealized gross losses gross gains $ 4 149 336 128 464 75 692 349 $1,041 $ (10) (6) $ 839 3,191 $ 1,128 3,429 $ 16 196 $ (4) (4) $ 1,140 3,621 (24) 25,616 20,198 750 (4) 20,944 (6) (30) (55) (101) (7) 6,750 32,366 4,538 40,934 900 4,082 24,280 2,974 31,811 507 $(108) $41,834 $32,318 121 871 157 1,240 198 $1,438 (4) (8) (14) (30) (9) $(39) 4,199 25,143 3,117 33,021 696 $33,717 (1) Substantially all of the private collateralized mortgage obligations are AAA-rated bonds collateralized by 1-4 family residential ﬁrst mortgages. (2) At December 31, 2005, we held no securities of any single issuer (excluding the U.S.Treasury and federal agencies) with a book value that exceeded 10% of stockholders’ equity. The following table shows the unrealized gross losses and fair value of securities in the securities available for sale portfolio at December 31, 2005 and 2004, by length of time that individual securities in each category had been in a continuous loss position. The decline in fair value for the debt securities that had been in a continuous loss position for 12 months or more at December 31, 2005, was primarily due to changes in market interest rates and not due to the credit quality of the securities. We believe that the principal and interest on these securities are fully collectible and we have the intent and ability to retain our investment for a period of time to allow for any anticipated recovery in market value. We have reviewed these securities in accordance with our policy and do not consider them to be other-than-temporarily impaired. (in millions) Less than 12 months Fair value Unrealized gross losses 12 months or more Fair value Unrealized gross losses Unrealized gross losses Total Fair value December 31, 2005 Securities of U.S. Treasury and federal agencies Securities of U.S. states and political subdivisions Mortgage-backed securities: Federal agencies Private collateralized mortgage obligations Total mortgage-backed securities Other Total debt securities Marketable equity securities Total December 31, 2004 Securities of U.S. Treasury and federal agencies Securities of U.S. states and political subdivisions Mortgage-backed securities: Federal agencies Private collateralized mortgage obligations Total mortgage-backed securities Other Total debt securities Marketable equity securities Total $ (6) (3) (22) (6) (28) (38) (75) (7) $(82) $ (4) (1) (4) (4) (8) (11) (24) (9) $(33) $ 341 204 2,213 1,494 3,707 890 5,142 185 $5,327 $ 304 65 450 981 1,431 584 2,384 44 $ 2,428 $ (4) (3) (2) — (2) (17) (26) — $(26) $ — (3) — — — (3) (6) — $ (6) $142 57 89 — 89 338 626 — $626 $ — 62 — — — 56 118 — $118 $ (10) (6) $ 483 261 (24) 2,302 (6) (30) (55) (101) (7) $(108) $ (4) (4) (4) (4) (8) (14) (30) (9) $ (39) 1,494 3,796 1,228 5,768 185 $5,953 $ 304 127 450 981 1,431 640 2,502 44 $ 2,546 71 Securities pledged where the secured party has the right to sell or repledge totaled $5.3 billion at December 31, 2005, and $2.3 billion at December 31, 2004. Securities pledged where the secured party does not have the right to sell or repledge totaled $24.3 billion at December 31, 2005, and $19.4 billion at December 31, 2004, primarily to secure trust and public deposits and for other purposes as required or permitted by law. We have accepted collateral in the form of securities that we have the right to sell or repledge of $3.4 billion at December 31, 2005, and $2.5 billion at December 31, 2004, of which we sold or repledged $2.3 billion and $1.7 billion, respectively. The following table shows the realized net gains on the sales of securities from the securities available for sale portfolio, including marketable equity securities. (in millions) Realized gross gains Realized gross losses (1) Realized net gains 2005 $ 355 (315) $ 40 Year ended December 31, 2003 2004 $ 168 (108) $ 60 $ 178 (116) $ 62 (1) Includes other-than-temporary impairment of $45 million, $9 million and $50 million for 2005, 2004 and 2003, respectively. The following table shows the remaining contractual principal maturities and contractual yields of debt securities available for sale. The remaining contractual principal maturities for mortgage-backed securities were allocated assuming no prepayments. Remaining expected maturities will differ from contractual maturities because borrowers may have the right to prepay obligations before the underlying mortgages mature. (in millions) amount Total Weighted- average yield December 31, 2005 Remaining contractual principal maturity Within one year Yield Amount After one year through ﬁve years Yield Amount After five years through ten years Yield Amount After ten years Yield Amount Securities of U.S. Treasury and federal agencies Securities of U.S. states and political subdivisions Mortgage-backed securities: Federal agencies Private collateralized mortgage obligations Total mortgage-backed securities Other Total debt securities at fair value (1) $ 839 4.38% $ 50 5.11% $ 677 4.21% $ 93 4.69% $ 19 6.88% 3,191 25,616 6,750 32,366 4,538 $40,934 7.57 5.68 5.40 5.62 6.11 5.80% 86 33 — 33 225 $394 6.63 6.02 — 6.02 5.80 281 6.06 560 7.25 2,264 7.87 49 6.51 69 5.91 25,465 5.68 — 49 2,773 — 6.51 5.70 42 111 953 6.45 6.12 7.13 6,708 32,173 587 5.40 5.62 6.53 5.91% $3,780 5.47% $1,717 6.97% $35,043 5.78% (1) The weighted-average yield is computed using the contractual life amortization method. 72 Note 6: Loans and Allowance for Credit Losses A summary of the major categories of loans outstanding is shown in the following table. Outstanding loan balances reﬂect unearned income, net deferred loan fees, and unamor- tized discount and premium totaling $3,918 million and $3,766 million at December 31, 2005 and 2004, respectively. Loan concentrations may exist when there are amounts loaned to a multiple number of borrowers engaged in similar activities or similar types of loans extended to a diverse group of borrowers that would cause them to be similarly impacted by economic or other conditions. At December 31, 2005 and 2004, we did not have concentrations representing 10% or more of our total loan portfolio in commercial loans (by industry); commercial real estate loans (other real estate mortgage and real estate construction) (by state or property type); or other revolving credit and installment loans (by product type). Our real estate 1-4 family mortgage loans to borrowers in the state of California represented approximately 14% of total loans at December 31, 2005, compared with 18% at the end of 2004. These loans are mostly within the larger metropolitan areas in California, with no single area consisting of more than 3% of our total loans. Changes in real estate values and underlying economic conditions for these areas are monitored continuously within our credit risk management process. Some of our real estate 1-4 family mortgage loans, including ﬁrst mortgage and home equity products, include an interest- only feature as part of the loan terms. At December 31, 2005, such loans were approximately 26% of total loans, compared with 28% at the end of 2004. Substantially all of these loans are considered to be prime or near prime. We do not offer option adjustable-rate mortgage products, nor do we offer variable-rate mortgage products with ﬁxed payment amounts, commonly referred to within the ﬁnancial services industry as negative amortizing mortgage loans. (in millions) Commercial and commercial real estate: Commercial Other real estate mortgage Real estate construction Lease ﬁnancing Total commercial and commercial real estate Consumer: Real estate 1-4 family ﬁrst mortgage Real estate 1-4 family junior lien mortgage Credit card Other revolving credit and installment Total consumer Foreign Total loans December 31, 2001 2005 2003 2004 2002 $ 61,552 28,545 13,406 5,400 108,903 77,768 59,143 12,009 47,462 196,382 5,552 $310,837 $ 54,517 29,804 9,025 5,169 98,515 87,686 52,190 10,260 34,725 184,861 4,210 $287,586 $ 48,729 27,592 8,209 4,477 89,007 83,535 36,629 8,351 33,100 161,615 2,451 $253,073 $ 47,292 25,312 7,804 4,085 84,493 44,119 28,147 7,455 26,353 106,074 1,911 $192,478 $ 47,547 24,808 7,806 4,017 84,178 29,317 21,801 6,700 23,502 81,320 1,598 $167,096 For certain extensions of credit, we may require collateral, based on our assessment of a customer’s credit risk. We hold various types of collateral, including accounts receivable, inventory, land, buildings, equipment, automobiles, ﬁnancial instruments, income-producing commercial properties and residential real estate. Collateral requirements for each customer may vary according to the speciﬁc credit underwriting, terms and structure of loans funded immediately or under a commitment to fund at a later date. A commitment to extend credit is a legally binding agree- ment to lend funds to a customer, usually at a stated interest rate and for a speciﬁed purpose. These commitments have ﬁxed expiration dates and generally require a fee. When we make such a commitment, we have credit risk. The liquidity requirements or credit risk will be lower than the contractual amount of commitments to extend credit because a signiﬁcant portion of these commitments are expected to expire without being used. Certain commitments are subject to loan agree- ments with covenants regarding the ﬁnancial performance of the customer that must be met before we are required to fund the commitment. We use the same credit policies in extending credit for unfunded commitments and letters of credit that we use in making loans. For information on standby letters of credit, see Note 24. 73 In addition, we manage the potential risk in credit com- mitments by limiting the total amount of arrangements, both by individual customer and in total, by monitoring the size and maturity structure of these portfolios and by applying the same credit standards for all of our credit activities. The total of our unfunded loan commitments, net of all funds lent and all standby and commercial letters of credit issued under the terms of these commitments, is summarized by loan category in the following table: (in millions) Commercial and commercial real estate: Commercial Other real estate mortgage Real estate construction Total commercial and commercial real estate Consumer: Real estate 1-4 family ﬁrst mortgage Real estate 1-4 family junior lien mortgage Credit card Other revolving credit and installment Total consumer Foreign December 31, 2004 2005 $ 71,548 2,398 9,369 $ 59,603 2,788 7,164 83,315 69,555 10,229 37,909 45,270 13,957 107,365 675 9,009 31,396 38,200 15,427 94,032 407 Total unfunded loan commitments $191,355 $163,994 We have an established process to determine the adequacy of the allowance for credit losses that assesses the risks and losses inherent in our portfolio. This process supports an allowance consisting of two components, allocated and unallocated. For the allocated component, we combine estimates of the allowances needed for loans analyzed on a pooled basis and loans analyzed individually (including impaired loans). Approximately two-thirds of the allocated allowance is determined at a pooled level for consumer loans and some segments of commercial small business loans. We use fore- casting models to measure inherent loss in these portfolios. We frequently validate and update these models to capture recent behavioral characteristics of the portfolios, as well as changes in our loss mitigation or marketing strategies. The remaining allocated allowance is for commercial loans, commercial real estate loans and lease ﬁnancing. We initially estimate this portion of the allocated allowance by applying historical loss factors statistically derived from tracking loss content associated with actual portfolio movements over a speciﬁed period of time, using a standardized loan grading process. 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. Also, we individually review nonperforming loans over $3 million for impairment based on cash ﬂows or collateral. We include the impairment on these nonperforming loans in the allocated allowance unless it has already been recognized as a loss. The potential risk from unfunded loan commitments and letters of credit for wholesale loan portfolios is considered along with the loss analysis of loans outstanding. Unfunded commercial loan commitments and letters of credit are converted to a loan equivalent factor as part of the analysis. The reserve for unfunded credit commitments was $186 million at December 31, 2005, and $188 million at December 31, 2004, both representing less than 5% of the total allowance for credit losses. The allocated allowance is supplemented by the unallo- cated allowance to adjust for imprecision and to incorporate the range of probable outcomes inherent in estimates used for the allocated allowance. The unallocated allowance is the result of our judgment of risks inherent in the portfolio, economic uncertainties, historical loss experience and other subjective factors, including industry trends. No material changes in estimation methodology for the allowance for credit losses were made in 2005. The ratios of the allocated allowance and the unallocated allowance to the total allowance may change from period to period. The total allowance reﬂects management’s estimate of credit losses inherent in the loan portfolio, including unfunded credit commitments, at December 31, 2005. Like all national banks, our subsidiary national banks continue to be subject to examination by their primary regulator, the Ofﬁce of the Comptroller of the Currency (OCC), and some have OCC examiners in residence. The OCC examinations occur throughout the year and target various activities of our subsidiary national banks, including both the loan grading system and speciﬁc segments of the loan portfolio (for example, commercial real estate and shared national credits). The Parent and its nonbank subsidiaries are examined by the Federal Reserve Board. We consider the allowance for credit losses of $4.06 billion adequate to cover credit losses inherent in the loan portfolio, including unfunded credit commitments, at December 31, 2005. 74 The allowance for credit losses consists of the allowance for loan losses and the reserve for unfunded credit commitments. Changes in the allowance for credit losses were: (in millions) Balance, beginning of year Provision for credit losses Loan charge-offs: Commercial and commercial real estate: Commercial Other real estate mortgage Real estate construction Lease ﬁnancing Total commercial and commercial real estate Consumer: Real estate 1-4 family ﬁrst mortgage Real estate 1-4 family junior lien mortgage Credit card Other revolving credit and installment Total consumer Foreign Total loan charge-offs Loan recoveries: Commercial and commercial real estate: Commercial Other real estate mortgage Real estate construction Lease ﬁnancing Total commercial and commercial real estate Consumer: Real estate 1-4 family ﬁrst mortgage Real estate 1-4 family junior lien mortgage Credit card Other revolving credit and installment Total consumer Foreign Total loan recoveries Net loan charge-offs Other Balance, end of year Components: Allowance for loan losses Reserve for unfunded credit commitments (1) Allowance for credit losses Net loan charge-offs as a percentage of average total loans Allowance for loan losses as a percentage of total loans Allowance for credit losses as a percentage of total loans 2005 $ 3,950 2,383 (406) (7) (6) (35) (454) (111) (136) (553) (1,480) (2,280) (298) (3,032) 133 16 13 21 183 21 31 86 365 503 63 749 (2,283) 7 $ 4,057 $ 3,871 186 $ 4,057 2004 $ 3,891 1,717 (424) (25) (5) (62) (516) (53) (107) (463) (919) (1,542) (143) (2,201) 150 17 6 26 199 6 24 62 220 312 24 535 (1,666) 8 $ 3,950 $ 3,762 188 $ 3,950 2003 $ 3,819 1,722 (597) (33) (11) (41) (682) (47) (77) (476) (827) (1,427) (105) (2,214) 177 11 11 8 207 10 13 50 196 269 19 495 (1,719) 69 $ 3,891 $ 3,891 — $ 3,891 Year ended December 31, 2001 2002 $ 3,717 1,684 $ 3,681 1,727 (716) (24) (40) (21) (801) (39) (55) (407) (770) (1,271) (84) (2,156) 162 16 19 — 197 8 10 47 205 270 14 481 (1,675) 93 $ 3,819 $ 3,819 — $ 3,819 (692) (32) (37) (22) (783) (40) (36) (421) (770) (1,267) (78) (2,128) 96 22 3 — 121 6 8 40 203 257 18 396 (1,732) 41 $ 3,717 $ 3,717 — $ 3,717 .77% 1.25% 1.31 .62% 1.31% 1.37 .81% 1.54% 1.54 .96% 1.98% 1.98 1.10% 2.22% 2.22 (1) Effective September 30, 2004, we transferred the portion of the allowance for loan losses related to commercial lending commitments and letters of credit to other liabilities. 75 The average recorded investment in impaired loans during 2005, 2004 and 2003 was $260 million, $481 million and $668 million, respectively. All of our impaired loans are on nonaccrual status. When the ultimate collectibility of the total principal of an impaired loan is in doubt, all payments are applied to principal, under the cost recovery method. When the ultimate collectibility of the total principal of an impaired loan is not in doubt, contractual interest is credited to interest income when received, under the cash basis method. Total interest income recognized for impaired loans in 2005, 2004 and 2003 under the cash basis method was not signiﬁcant. Nonaccrual loans were $1,338 million and $1,358 million at December 31, 2005 and 2004, respectively. Loans past due 90 days or more as to interest or principal and still accruing interest were $3,606 million at December 31, 2005, and $2,578 million at December 31, 2004. The 2005 and 2004 balances included $2,923 million and $1,820 million, respectively, in advances pursuant to our servicing agree- ments to the Government National Mortgage Association mortgage pools whose repayments are insured by the Federal Housing Administration or guaranteed by the Department of Veteran Affairs. The recorded investment in impaired loans and the methodology used to measure impairment was: (in millions) Impairment measurement based on: Collateral value method Discounted cash ﬂow method Total (1) December 31, 2004 2005 $115 75 $190 $183 126 $309 (1) Includes $56 million and $107 million of impaired loans with a related allowance of $10 million and $17 million at December 31, 2005 and 2004, respectively. 76 Note 7: Premises, Equipment, Lease Commitments and Other Assets (in millions) Land Buildings Furniture and equipment Leasehold improvements Premises and equipment leased under capital leases Total premises and equipment Less: Accumulated depreciation and amortization 2005 $ 649 3,617 3,425 1,115 60 8,866 4,449 Net book value, premises and equipment $4,417 December 31, 2004 $ 585 2,974 3,110 1,049 60 7,778 3,928 $3,850 Depreciation and amortization expense for premises and equipment was $810 million, $654 million and $666 million in 2005, 2004 and 2003, respectively. Net gains (losses) on dispositions of premises and equipment, included in noninterest expense, were $56 million, $(5) million and $(46) million in 2005, 2004 and 2003, respectively. We have obligations under a number of noncancelable operating leases for premises (including vacant premises) and equipment. The terms of these leases, including renewal options, are predominantly up to 15 years, with the longest up to 72 years, and many provide for periodic adjustment of rentals based on changes in various economic indicators. The future minimum payments under noncancelable operating leases and capital leases, net of sublease rentals, with terms greater than one year as of December 31, 2005, were: (in millions) Operating leases Capital leases Year ended December 31, 2006 2007 2008 2009 2010 Thereafter Total minimum lease payments Executory costs Amounts representing interest Present value of net minimum lease payments $ 514 426 360 298 237 898 $2,733 $ 4 2 2 1 1 14 24 (2) (8) $14 Operating lease rental expense (predominantly for premises), net of rental income, was $583 million, $586 million and $574 million in 2005, 2004 and 2003, respectively. The components of other assets were: (in millions) Nonmarketable equity investments: Private equity investments Federal bank stock All other Total nonmarketable equity investments (1) Operating lease assets Accounts receivable Interest receivable Core deposit intangibles Foreclosed assets Due from customers on acceptances Other December 31, 2004 2005 $ 1,537 1,402 2,151 5,090 3,414 11,606 2,279 489 191 104 9,299 $ 1,449 1,713 2,067 5,229 3,642 2,682 1,483 603 212 170 8,470 Total other assets $32,472 $22,491 (1) At December 31, 2005 and 2004, $3.1 billion and $3.3 billion, respectively, of nonmarketable equity investments, including all federal bank stock, were accounted for at cost. Income related to nonmarketable equity investments was: (in millions) Year ended December 31, 2003 2004 2005 Net gains (losses) from private equity investments Net gains from all other nonmarketable equity investments Net gains from nonmarketable equity investments $351 $319 $ (3) 43 33 116 $394 $352 $113 77 77 Note 8: Intangible Assets The gross carrying amount of intangible assets and accumulated amortization was: (in millions) 2005 Gross Accumulated carrying amortization amount December 31, 2004 Gross Accumulated carrying amortization amount As of December 31, 2005, the current year and estimated future amortization expense for amortized intangible assets was: (in millions) Mortgage servicing rights Core deposit intangibles Other Total Amortized intangible assets: Mortgage servicing rights, before valuation allowance (1) Core deposit intangibles Other Total amortized $ 25,126 $ 11,428 $ 18,903 $ 9,437 2,432 567 1,943 312 2,426 567 1,823 296 2006 2007 2008 2009 2010 Year ended December 31, 2005 Estimate for year ended December 31, $1,991 $123 $55 $2,169 $ 1,959 1,659 1,426 1,246 1,068 $111 101 93 85 77 $ 48 46 30 25 23 $ 2,118 1,806 1,549 1,356 1,168 intangible assets $28,125 $13,683 $21,896 $11,556 Unamortized intangible asset (trademark) $ 14 $ 14 (1) See Note 21 for additional information on MSRs and the related valuation allowance. We based the projections of amortization expense for mortgage servicing rights shown above on existing asset balances and the existing interest rate environment as of December 31, 2005. Future amortization expense may be signiﬁcantly different depending upon changes in the mortgage servicing portfolio, mortgage interest rates and market conditions. We based the projections of amortization expense for core deposit intangibles shown above on existing asset balances at December 31, 2005. Future amortization expense may vary based on additional core deposit intangibles acquired through business combinations. 78 Note 9: Goodwill The changes in the carrying amount of goodwill as allocated to our operating segments for goodwill impairment analysis were: (in millions) December 31, 2003 Goodwill from business combinations Foreign currency translation adjustments December 31, 2004 Reduction in goodwill related to divested businesses Goodwill from business combinations Realignment of automobile ﬁnancing business Foreign currency translation adjustments December 31, 2005 Community Banking Wholesale Banking Wells Fargo Financial Consolidated Company $ 7,286 5 — 7,291 (31) 125 (11) — $7,374 $ 2,735 302 — 3,037 (3) 13 — — $3,047 $ 350 — 3 353 — — 11 2 $366 $ 10,371 307 3 10,681 (34) 138 — 2 $10,787 For goodwill impairment testing, enterprise-level goodwill acquired in business combinations is allocated to reporting units based on the relative fair value of assets acquired and recorded in the respective reporting units. Through this allocation, we assigned enterprise-level goodwill to the reporting units that are expected to beneﬁt from the synergies of the combination. We used discounted estimated future net cash ﬂows to evaluate goodwill reported at all reporting units. For our goodwill impairment analysis, we allocate all of the goodwill to the individual operating segments. For management reporting we do not allocate all of the goodwill to the individual operating segments: some is allocated at the enterprise level. See Note 19 for further information on management reporting. The balances of goodwill for management reporting were: (in millions) December 31, 2004 December 31, 2005 Community Banking $ 3,433 $3,527 Wholesale Banking $ 1,087 $1,097 Wells Fargo Financial $364 $366 Enterprise $ 5,797 $5,797 Consolidated Company $ 10,681 $10,787 79 Note 10: Deposits The total of time certiﬁcates of deposit and other time deposits issued by domestic ofﬁces was $74,023 million and $55,495 million at December 31, 2005 and 2004, respectively. Substantially all of those deposits were interest bearing. The contractual maturities of those deposits were: (in millions) 2006 2007 2008 2009 2010 Thereafter Total December 31, 2005 $66,700 3,886 1,899 769 538 231 $74,023 Of those deposits, the amount of time deposits with a denomination of $100,000 or more was $56,123 million and $41,851 million at December 31, 2005 and 2004, respectively. The contractual maturities of these deposits were: (in millions) December 31, 2005 Three months or less After three months through six months After six months through twelve months After twelve months Total $45,763 2,154 5,867 2,339 $56,123 Time certiﬁcates of deposit and other time deposits issued by foreign ofﬁces with a denomination of $100,000 or more represent the majority of all of our foreign deposit liabilities of $14,621 million and $8,533 million at December 31, 2005 and 2004, respectively. Demand deposit overdrafts of $618 million and $470 mil- lion were included as loan balances at December 31, 2005 and 2004, respectively. Note 11: Short-Term Borrowings The table below shows selected information for short-term borrowings, which generally mature in less than 30 days. (in millions) Amount 2005 Rate 2004 Rate Amount 2003 Rate Amount As of December 31, Commercial paper and other short-term borrowings Federal funds purchased and securities sold under agreements to repurchase Total Year ended December 31, Average daily balance Commercial paper and other short-term borrowings Federal funds purchased and securities sold under agreements to repurchase Total Maximum month-end balance Commercial paper and other short-term borrowings (1) Federal funds purchased and securities sold under agreements to repurchase (2) $ 3,958 3.80% $ 6,225 2.40% $ 6,709 1.26% 19,934 $23,892 3.99 3.96 15,737 $21,962 2.04 2.14 17,950 $24,659 .84 .95 $ 9,548 3.09% $10,010 1.56% $11,506 1.22% 14,526 $24,074 3.09 3.09 16,120 $26,130 $15,075 N/A $16,492 22,315 N/A 22,117 1.22 1.35 N/A N/A 18,392 $29,898 $14,462 24,132 .99 1.08 N/A N/A N/A – Not applicable. (1) Highest month-end balance in each of the last three years was in January 2005, July 2004 and January 2003. (2) Highest month-end balance in each of the last three years was in August 2005, June 2004 and April 2003. 80 Note 12: Long-Term Debt Following is a summary of our long-term debt based on original maturity (reﬂecting unamortized debt discounts and premiums, where applicable): (in millions) Wells Fargo & Company (Parent only) Senior Fixed-Rate Notes (1) Floating-Rate Notes Extendable Notes (2) Equity-Linked Notes (3) Convertible Debenture (4) Total senior debt – Parent Subordinated Fixed-Rate Notes (1) FixFloat Notes Total subordinated debt – Parent Junior Subordinated Fixed-Rate Notes (1)(5) Total junior subordinated debt – Parent Total long-term debt – Parent Wells Fargo Bank, N.A. and its subsidiaries (WFB, N.A.) Senior Fixed-Rate Notes (1) Floating-Rate Notes Floating-Rate Federal Home Loan Bank (FHLB) Advances (6) FHLB Notes and Advances Equity-Linked Notes (3) Notes payable by subsidiaries Obligations of subsidiaries under capital leases (Note 7) Total senior debt – WFB, N.A. Subordinated FixFloat Notes (7) Fixed-Rate Notes (1) Other notes and debentures Total subordinated debt – WFB, N.A. Total long-term debt – WFB, N.A. Wells Fargo Financial, Inc., and its subsidiaries (WFFI) Senior Fixed-Rate Notes Floating-Rate Notes Total long-term debt – WFFI Maturity date(s) 2006-2035 2006-2015 2008-2015 2006-2014 2033 2011-2023 2012 Stated interest rate(s) 2.20-6.875% Varies Varies Varies Varies 4.625-6.65% 4.00% through 2006, varies 2031-2034 5.625-7.00% 2006-2019 2006-2034 — 2012 2006-2014 — — 2010-2015 2006-2013 1.16-4.24% Varies — 5.20% Varies — — 4.07-7.55% 4.50-12.00% 2005 December 31, 2004 $16,081 21,711 10,000 444 3,000 51,236 4,558 300 4,858 3,247 3,247 59,341 256 3,138 — 203 229 — 14 3,840 — 4,330 13 4,343 8,183 $12,970 20,155 5,500 472 3,000 42,097 4,502 299 4,801 3,248 3,248 50,146 218 7,615 1,400 200 40 79 19 9,571 998 2,821 11 3,830 13,401 2006-2034 2007-2010 2.06-7.47% Varies 7,159 1,714 $ 8,873 5,343 1,303 $ 6,646 (1) We entered into interest rate swap agreements for a major portion of these notes, whereby we receive ﬁxed-rate interest payments approximately equal to interest on the notes and make interest payments based on an average one-month, three-month or six-month London Interbank Offered Rate (LIBOR). (2) The extendable notes are ﬂoating-rate securities with an initial maturity of 13 months or 2 years, which can be extended, respectively, on a rolling monthly basis, to a ﬁnal maturity of 5 or 6 years, or, on a 6 month rolling basis, to a ﬁnal maturity of 10 years, at the investor’s option. (3) These notes are linked to baskets of equities, commodities or equity indices. (4) On April 15, 2003, we issued $3 billion of convertible senior debentures as a private placement. In November 2004, we amended the indenture under which the debentures were issued to eliminate a provision in the indenture that prohibited us from paying cash upon conversion of the debentures if an event of default as deﬁned in the indenture exists at the time of conversion. We then made an irrevocable election under the indenture on December 15, 2004, that upon conversion of the debentures, we must satisfy the accreted value of the obligation (the amount accrued to the beneﬁt of the holder exclusive of the conversion spread) in cash and may satisfy the conversion spread (the excess conversion value over the accreted value) in either cash or stock. We can also redeem all or some of the convertible debt securities for cash at any time on or after May 5, 2008, at their principal amount plus accrued interest, if any. (5) Effective December 31, 2003, as a result of the adoption of FIN 46R we deconsolidated certain wholly-owned trusts formed for the sole purpose of issuing trust preferred securities (the Trusts). The junior subordinated debentures held by the Trusts are included in the Company’s long-term debt. (6) During 2005, the FHLB exercised their put options on all outstanding ﬂoating-rate advances. (7) Note was called in June 2005. (continued on following page) 81 Maturity date(s) 2006-2045 2008-2009 2012 2006-2009 2011-2015 2026-2031 2027-2034 Stated interest rate(s) 1.50-6.90% Varies Varies 1.00-13.87% Varies 7.73-10.18% Varies 2005 December 31, 2004 $ 502 500 14 — 1,016 1,138 66 1,204 869 182 1,051 3,271 $79,668 $ 564 500 1 1 1,066 1,194 95 1,289 865 167 1,032 3,387 $73,580 The interest rates on ﬂoating-rate notes are determined periodically by formulas based on certain money market rates, subject, on certain notes, to minimum or maximum interest rates. As part of our long-term and short-term borrowing arrangements, we are subject to various ﬁnancial and operational covenants. Some of the agreements under which debt has been issued have provisions that may limit the merger or sale of certain subsidiary banks and the issuance of capital stock or convertible securities by certain subsidiary banks. At December 31, 2005, we were in compliance with all the covenants. (continued from previous page) (in millions) Other consolidated subsidiaries Senior Fixed-Rate Notes Floating-Rate FHLB Advances Other notes and debentures – Floating-Rate Obligations of subsidiaries under capital leases (Note 7) Total senior debt – Other consolidated subsidiaries Subordinated Fixed-Rate Notes (1) Other notes and debentures – Floating-Rate Total subordinated debt – Other consolidated subsidiaries Junior Subordinated Fixed-Rate Notes (5) Floating-Rate Notes (5) Total junior subordinated debt – Other consolidated subsidiaries Total long-term debt – Other consolidated subsidiaries Total long-term debt At December 31, 2005, aggregate annual maturities of long-term debt obligations (based on ﬁnal maturity dates) were as follows: (in millions) 2006 2007 2008 2009 2010 Thereafter Total Parent $ 7,309 10,557 11,648 5,904 6,911 17,012 $59,341 Company $11,124 13,962 13,742 6,926 8,943 24,971 $79,668 82 Note 13: Preferred Stock We are authorized to issue 20 million shares of preferred stock and 4 million shares of preference stock, both without par value. Preferred shares outstanding rank senior to com- mon shares both as to dividends and liquidation preference but have no general voting rights. We have not issued any preference shares under this authorization. ESOP CUMULATIVE CONVERTIBLE PREFERRED STOCK All shares of our ESOP (Employee Stock Ownership Plan) Cumulative Convertible Preferred Stock (ESOP Preferred Stock) were issued to a trustee acting on behalf of the Wells Fargo & Company 401(k) Plan (the 401(k) Plan). Dividends on the ESOP Preferred Stock are cumulative from the date of initial issuance and are payable quarterly at annual rates ranging from 8.50% to 12.50%, depending upon the year of issuance. Each share of ESOP Preferred Stock released from the unallocated reserve of the 401(k) Plan is converted into shares of our common stock based on the stated value of the ESOP Preferred Stock and the then current market price of our common stock. The ESOP Preferred Stock is also convertible at the option of the holder at any time, unless previously redeemed. We have the option to redeem the ESOP Preferred Stock at any time, in whole or in part, at a redemption price per share equal to the higher of (a) $1,000 per share plus accrued and unpaid dividends or (b) the fair market value, as deﬁned in the Certiﬁcates of Designation for the ESOP Preferred Stock. Shares issued and outstanding December 31, 2004 2005 Carrying amount (in millions) December 31, 2004 2005 Adjustable dividend rate Maximum Minimum ESOP Preferred Stock (1): 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 Total ESOP Preferred Stock Unearned ESOP shares (2) 102,184 74,880 52,643 39,754 28,263 19,282 6,368 1,953 136 — 89,420 60,513 46,694 34,279 24,362 8,722 2,985 2,206 $ 102 $ — 9.75% 10.75% 75 53 40 28 19 6 2 — 90 61 47 34 24 9 3 2 8.50 8.50 10.50 10.50 11.50 10.30 10.75 9.50 8.50 9.50 9.50 11.50 11.50 12.50 11.30 11.75 10.50 9.50 — 325,463 382 269,563 — $ 325 $(348) — $ 270 $(289) (1) Liquidation preference $1,000. (2) In accordance with the American Institute of Certiﬁed Public Accountants (AICPA) Statement of Position 93-6, Employers’ Accounting for Employee Stock Ownership Plans, we recorded a corresponding charge to unearned ESOP shares in connection with the issuance of the ESOP Preferred Stock. The unearned ESOP shares are reduced as shares of the ESOP Preferred Stock are committed to be released. For information on dividends paid, see Note 14. 83 Note 14: Common Stock and Stock Plans Common Stock Our reserved, issued and authorized shares of common stock at December 31, 2005, were: Dividend reinvestment and common stock purchase plans Director plans Stock plans (1) Total shares reserved Shares issued Shares not reserved Total shares authorized Number of shares 3,088,307 651,102 307,357,126 311,096,535 1,736,381,025 3,952,522,440 6,000,000,000 (1) Includes employee option, restricted shares and restricted share rights, 401(k), proﬁt sharing and compensation deferral plans. Dividend Reinvestment and Common Stock Purchase Plans Participants in our dividend reinvestment and common stock direct purchase plans may purchase shares of our common stock at fair market value by reinvesting dividends and/or making optional cash payments, under the plan’s terms. Director Plans We provide a stock award to non-employee directors as part of their annual retainer under our director plans. We also provide annual grants of options to purchase common stock to each non-employee director elected or re-elected at the annual meeting of stockholders. The options can be exercised after six months and through the tenth anniversary of the grant date. Employee Stock Plans LONG-TERM INCENTIVE PLANS Our stock incentive plans provide for awards of incentive and nonqualiﬁed stock options, stock appreciation rights, restricted shares, restricted share rights, performance awards and stock awards without restrictions. Options must have an exercise price at or above fair market value (as deﬁned in the plan) of the stock at the date of grant (except for substitute or replacement options granted in connection with mergers or other acquisitions) and a term of no more than 10 years. Options granted in 2003 and prior generally become exercisable over three years from the date of grant. Options granted in 2004 and the beginning of 2005 generally were fully vested upon grant. Effective April 26, 2005, options granted under our plan generally cannot fully vest in less than one year. Options granted generally have a contractual term of 10 years. Except as otherwise permitted under the plan, if employment is ended for reasons other than retirement, permanent disability or death, the option period is reduced or the options are canceled. 84 Options also may include the right to acquire a “reload” stock option. If an option contains the reload feature and if a participant pays all or part of the exercise price of the option with shares of stock purchased in the market or held by the participant for at least six months, upon exercise of the option, the participant is granted a new option to purchase, at the fair market value of the stock as of the date of the reload, the number of shares of stock equal to the sum of the number of shares used in payment of the exercise price and a number of shares with respect to related statutory minimum withholding taxes. Options granted after 2003 did not include a reload feature. We did not record any compensation expense for the options granted under the plans during 2005, 2004 and 2003, as the exercise price was equal to the quoted market price of the stock at the date of grant. The total number of shares of common stock available for grant under the plans at December 31, 2005, was 116,604,733. Holders of restricted shares and restricted share rights are entitled to the related shares of common stock at no cost generally over three to ﬁve years after the restricted shares or restricted share rights were granted. Holders of restricted shares generally are entitled to receive cash dividends paid on the shares. Holders of restricted share rights generally are entitled to receive cash payments equal to the cash dividends that would have been paid had the restricted share rights been issued and outstanding shares of common stock. Except in limited circumstances, restricted shares and restricted share rights are canceled when employment ends. In 2005, 26,400 restricted shares and restricted share rights were granted with a weighted-average grant-date per share fair value of $61.59. In 2004, no restricted shares or restricted share rights were granted. In 2003, 61,740 restricted shares and restricted share rights were granted with a weighted-average grant-date per share fair value of $56.05. At December 31, 2005, 2004 and 2003, there were 353,022, 448,150 and 577,722 restricted shares and restricted share rights outstanding, respectively. The compensation expense for the restricted shares and restricted share rights equals the quoted market price of the related stock at the date of grant and is accrued over the vesting period. We recognized total compensation expense for the restricted shares and restricted share rights of $2 million in 2005, $3 million in 2004 and $4 million in 2003. For various acquisitions and mergers since 1992, we converted employee and director stock options of acquired or merged companies into stock options to purchase our common stock based on the terms of the original stock option plan and the agreed-upon exchange ratio. BROAD-BASED PLANS In 1996, we adopted the PartnerShares® Stock Option Plan, a broad-based employee stock option plan. It covers full- and part-time employees who were generally not included in the long-term incentive plans described on the preceding page. The total number of shares of common stock authorized for issuance under the plan since inception through December 31, 2005, was 54,000,000, including 3,669,903 shares available for grant. No options have been granted under the PartnerShares Plan since 2002. The exercise date of options granted under the PartnerShares Plan is the earlier of (1) ﬁve years after the date of grant, or (2) when the quoted market price of the stock reaches a predetermined price. These options generally expire 10 years after the date of grant. Because the exercise price of each PartnerShares grant has been equal to or higher than the quoted market price of our common stock at the date of grant, we have not recognized any compensation expense in 2005 and prior years. The following table summarizes stock option activity and related information for the three years ended December 31, 2005. Director Plans Number Weighted-average exercise price Long-Term Incentive Plans Number Weighted-average exercise price Broad-Based Plans Weighted-average Number exercise price Options outstanding as of December 31, 2002 349,108 $ 36.78 93,379,737 $ 40.35 50,088,196 $ 43.25 2003: Granted Canceled Exercised Acquisitions Options outstanding as of December 31, 2003 2004: Granted Canceled Exercised Options outstanding as of December 31, 2004 2005: Granted Canceled Exercised Acquisitions Options outstanding as of December 31, 2005 Outstanding options exercisable as of: December 31, 2003 December 31, 2004 December 31, 2005 62,346 — (59,707) 4,769 356,516 50,960 — (21,427) 386,049 64,252 (3,594) (57,193) — 389,514 353,131 386,049 389,514 47.22 — 26.90 31.42 40.19 56.39 — 18.81 43.51 59.33 19.93 27.66 — 23,052,384 (1) (1,529,868) (13,884,561) 889,842 101,907,534 21,983,690 (1) (1,241,637) (18,574,660) 104,074,927 21,601,697(1) (623,384) (14,514,952) 52,824 46.04 46.76 31.96 25.89 42.56 57.41 48.06 37.89 46.46 60.12 51.80 42.20 27.35 — (4,293,930) (6,408,797) — 39,385,469 — (2,895,200) (3,792,605) 32,697,664 — (2,475,617) (5,729,286) — $48.67 110,591,112 $49.65 24,492,761 $ 40.08 43.51 48.67 63,257,541 84,702,073 103,053,320 $ 40.33 46.64 49.80 12,063,244 8,590,539 14,444,786 (1) Includes 4,014,597, 4,909,864 and 2,311,824 reload grants in 2005, 2004 and 2003, respectively. The following table presents the weighted-average per share fair value of options granted estimated using a Black- Scholes option-pricing model and the weighted-average assumptions used. Per share fair value of options granted: Director Plans Long-Term Incentive Plans Expected life (years) Expected volatility Risk-free interest rate Expected annual dividend yield 2005 2004 2003 $6.27 7.50 $9.34 9.32 $9.59 9.48 4.4 16.1% 4.0 3.4 4.4 23.8% 2.9 3.4 4.3 29.2% 2.5 2.9 — 46.85 34.09 — 44.35 — 48.26 34.84 45.10 — 47.51 42.78 — $45.51 $ 35.21 35.99 42.10 85 This table is a summary of our stock option plans described on the preceding page. Range of exercise prices Number Options outstanding Weighted-average remaining contractual life (in yrs.) Weighted-average exercise price December 31, 2005 Options exercisable Weighted-average Number exercise price Director Plans $13.49-$16.00 $16.01-$25.04 $25.05-$38.29 $38.30-$51.00 $51.01-$69.01 Long-Term Incentive Plans $3.37-$5.06 $5.07-$7.60 $11.42-$17.13 $17.14 -$25.71 $25.72-$38.58 $38.59-$71.30 Broad-Based Plans $16.56 $24.85-$37.81 $37.82-$46.50 $46.51-$51.15 2,530 17,010 34,620 197,942 137,412 29,012 4,366 101,430 57,574 16,442,280 93,956,450 287,403 5,107,673 8,661,248 10,436,437 $13.49 24.09 33.09 46.51 59.38 $ 4.23 5.84 16.53 23.33 34.24 52.41 $16.56 35.35 46.44 50.50 1.01 .49 1.88 5.60 7.69 6.50 20.02 .60 3.53 2.98 5.99 .56 2.42 4.86 6.22 2,530 17,010 34,620 197,942 137,412 29,012 4,366 101,430 57,574 16,277,280 86,583,658 287,403 5,107,673 8,540,348 509,362 $13.49 24.09 33.09 46.51 59.38 $ 4.23 5.84 16.53 23.33 34.22 52.80 $16.56 35.35 46.50 50.50 EMPLOYEE STOCK OWNERSHIP PLAN Under the Wells Fargo & Company 401(k) Plan (the 401(k) Plan), a deﬁned contribution ESOP, the 401(k) Plan may borrow money to purchase our common or preferred stock. Since 1994, we have loaned money to the 401(k) Plan to purchase shares of our ESOP Preferred Stock. As we release and convert ESOP Preferred Stock into common shares, we record compensation expense equal to the current market price of the common shares. Dividends on the common shares allocated as a result of the release and conversion of the ESOP Preferred Stock reduce retained earnings and the shares are considered outstanding for computing earnings per share. Dividends on the unallocated ESOP Preferred Stock do not reduce retained earnings, and the shares are not considered to be common stock equivalents for computing earnings per share. Loan principal and interest payments are made from our contributions to the 401(k) Plan, along with dividends paid on the ESOP Preferred Stock. With each principal and interest payment, a portion of the ESOP Preferred Stock is released and, after conversion of the ESOP Preferred Stock into common shares, allocated to the 401(k) Plan participants. The balance of ESOP shares, the dividends on allocated shares of common stock and unreleased preferred shares paid to the 401(k) Plan and the fair value of unearned ESOP shares were: (in millions, except shares) Shares outstanding __________December 31, 2003 2004 2005 Allocated shares (common) Unreleased shares (preferred) 36,917,501 325,463 33,921,758 269,563 31,927,982 214,100 Fair value of unearned ESOP shares $325 $270 $214 Dividends paid Year ended December 31, 2003 2004 $61 32 $46 26 2005 $71 39 Deferred Compensation Plan for Independent Sales Agents WF Deferred Compensation Holdings, Inc. is a wholly owned subsidiary of the Parent formed solely to sponsor a deferred compensation plan for independent sales agents who provide investment, ﬁnancial and other qualifying services for or with respect to participating afﬁliates. The plan, which became effective January 1, 2002, allows participants to defer all or part of their eligible compensation payable to them by a participating afﬁliate. The Parent has fully and unconditionally guaranteed the deferred compensation obligations of WF Deferred Compensation Holdings, Inc. under the plan. 86 Note 15: Employee Beneﬁts and Other Expenses Employee Beneﬁts We sponsor noncontributory qualiﬁed deﬁned beneﬁt retirement plans including the Cash Balance Plan. The Cash Balance Plan is an active plan that covers eligible employees (except employees of certain subsidiaries). Under the Cash Balance Plan, eligible employees’ Cash Balance Plan accounts are allocated a compensation credit based on a percentage of their certiﬁed compensation. The compensation credit percentage is based on age and years of credited service. In addition, investment credits are allocated to participants quarterly based on their accumulated balances. Employees become vested in their Cash Balance Plan accounts after completing ﬁve years of vesting service or reaching age 65, if earlier. Although we were not required to make a contribution in 2005 for our Cash Balance Plan, we funded the maximum amount deductible under the Internal Revenue Code, or $288 million. The total amount contributed for our pension plans was $340 million. We expect that we will not be required to make a contribution in 2006 for the Cash Balance Plan. The maximum we can contribute in 2006 for the Cash Balance Plan depends on several factors, including the ﬁnalization of participant data. Our decision on how much to contribute, if any, depends on other factors, including the actual investment performance of plan assets. Given these uncertainties, we cannot at this time reliably estimate the maximum deductible contribution or the amount that we will contribute in 2006 to the Cash Balance Plan. For the unfunded nonqualiﬁed pension plans and postretirement beneﬁt plans, we will contribute the minimum required amount in 2006, which equals the beneﬁts paid under the plans. In 2005, we paid $78 million in beneﬁts for the postretirement plans, which included $29 million in retiree contributions, and $13 million for the unfunded pension plans. We sponsor deﬁned contribution retirement plans including the 401(k) Plan. Under the 401(k) Plan, after one month of service, eligible employees may contribute up to 25% of their pretax certiﬁed compensation, although there may be a lower limit for certain highly compensated employees in order to maintain the qualiﬁed status of the 401(k) Plan. Eligible employees who complete one year of service are eligible for matching company contributions, which are generally a 100% match up to 6% of an employee’s certiﬁed compensation. The matching contributions generally vest over four years. Expenses for deﬁned contribution retirement plans were $370 million, $356 million and $257 million in 2005, 2004 and 2003, respectively. We provide health care and life insurance beneﬁts for certain retired employees and reserve the right to terminate or amend any of the beneﬁts at any time. The information set forth in the following tables is based on current actuarial reports using the measurement date of November 30 for our pension and postretirement beneﬁt plans. 87 The changes in the projected beneﬁt obligation during 2005 and 2004 and the amounts included in the Consolidated Balance Sheet at December 31, 2005 and 2004, were: (in millions) December 31, 2004 2005 Pension beneﬁts Pension beneﬁts Non- Non- qualiﬁed qualiﬁed Other beneﬁts Other beneﬁts Qualiﬁed Qualiﬁed Projected beneﬁt obligation at beginning of year Service cost Interest cost Plan participants’ contributions Amendments Actuarial gain (loss) Beneﬁts paid Foreign exchange impact Projected beneﬁt obligation at end of year $3,777 208 220 — 37 43 (242) 2 $4,045 $228 21 14 — — 27 (13) — $277 $751 21 41 29 (44) (12) (78) 1 $709 $3,387 170 215 — (54) 296 (240) 3 $3,777 $202 23 13 — (12) 27 (25) — $228 $698 17 43 26 (1) 37 (70) 1 $751 The weighted-average assumptions used to determine the The accumulated beneﬁt obligation for the deﬁned beneﬁt projected beneﬁt obligation were: pension plans was $4,076 million and $3,786 million at December 31, 2005 and 2004, respectively. 2005 Pension Other beneﬁts(1) beneﬁts Year ended December 31, 2004 Pension Other beneﬁts(1) beneﬁts Discount rate Rate of compensation increase 5.75% 4.0 5.75% — 6.0% 4.0 6.0% — (1) Includes both qualiﬁed and nonqualiﬁed pension beneﬁts. The changes in the fair value of plan assets during 2005 and 2004 were: (in millions) Fair value of plan assets at beginning of year Actual return on plan assets Employer contribution Plan participants’ contributions Beneﬁts paid Foreign exchange impact Fair value of plan assets at end of year 2005 Pension beneﬁts Non- qualiﬁed Qualiﬁed Other beneﬁts $4,457 400 327 — (242) 2 $4,944 $ — — 13 — (13) — $ — $329 34 56 29 (78) — $370 Year ended December 31, 2004 Pension beneﬁts Non- qualiﬁed Other beneﬁts Qualiﬁed $3,690 450 555 — (240) 2 $4,457 $ — — 25 — (25) — $ — $272 27 74 26 (70) — $329 We seek to achieve the expected long-term rate of return with a prudent level of risk given the beneﬁt obligations of the pension plans and their funded status. We target the Cash Balance Plan’s asset allocation for a target mix range of 40–70% equities, 20–50% ﬁxed income, and approximately 10% in real estate, venture capital, private equity and other investments. The target ranges employ a Tactical Asset Allocation overlay, which is designed to overweight stocks or bonds when a compelling opportunity exists. The Employee Beneﬁt Review Committee (EBRC), which includes several members of senior management, formally reviews the investment risk and performance of the Cash Balance Plan on a quarterly basis. Annual Plan liability analysis and periodic asset/liability evaluations are also conducted. 88 The weighted-average allocation of plan assets was: Pension plan assets Percentage of plan assets at December 31, 2004 Other beneﬁt plan assets 2005 Other beneﬁt plan assets Pension plan assets Equity securities Debt securities Real estate Other Total 69% 27 3 1 100% 58% 40 1 1 100% 63% 33 3 1 100% 51% 46 1 2 100% This table reconciles the funded status of the plans to the amounts included in the Consolidated Balance Sheet. (in millions) 2005 Pension beneﬁts Non- qualiﬁed Qualiﬁed December 31, 2004 Pension beneﬁts Non- qualiﬁed Other beneﬁts Other beneﬁts Qualiﬁed Funded status (1) Employer contributions in December Unrecognized net actuarial loss Unrecognized net transition asset Unrecognized prior service cost Accrued beneﬁt income (cost) Amounts recognized in the balance sheet consist of: Prepaid beneﬁt cost Accrued beneﬁt liability Accumulated other comprehensive income Accrued beneﬁt income (cost) $ 899 — 615 — (25) $1,489 $ 1,489 — — $ 1,489 $(277) 2 42 — (11) $(244) $ — (245) 1 $(244) $(339) 4 131 3 (51) $(252) $ — (252) — $(252) $ 680 — 647 — (67) $1,260 $1,260 — — $1,260 $(228) 1 25 — (20) $(222) $ — (223) 1 $(222) $(422) 5 158 3 (8) $(264) $ — (264) — $(264) (1) Fair value of plan assets at year end less projected beneﬁt obligation at year end. The table to the right provides information for pension plans with beneﬁt obligations in excess of plan assets, substantially due to our nonqualiﬁed pension plans. The net periodic beneﬁt cost was: (in millions) Projected beneﬁt obligation Accumulated beneﬁt obligation Fair value of plan assets December 31, 2004 2005 $359 297 60 $294 247 55 (in millions) Service cost Interest cost Expected return on plan assets Recognized net actuarial loss (gain) (1) Amortization of prior service cost Amortization of unrecognized transition asset Settlement Net periodic beneﬁt cost 2005 2004 Pension beneﬁts Non- qualiﬁed Qualiﬁed Other beneﬁts Pension beneﬁts Non- qualiﬁed Qualiﬁed Other beneﬁts $ 208 220 (393) 68 (4) — — $ 99 $21 14 — 3 (2) — — $36 $ 21 41 (25) 6 (1) — — $ 42 $ 170 215 (327) 51 (1) — (2) $23 13 — 1 (1) — 2 $ 17 43 (23) 2 (1) — — (1) Net actuarial loss (gain) is generally amortized over ﬁve years. Year ended December 31, 2003 Pension beneﬁts Non- qualiﬁed Qualiﬁed Other beneﬁts $ 164 209 (275) 85 16 — — $22 14 — 7 — — — $ 15 42 (18) (3) (1) 1 — $ 106 $38 $ 38 $ 199 $43 $ 36 89 The investment strategy for the postretirement plans is maintained separate from the strategy for the pension plans. The general target asset mix is 55–65% equities and 35–45% ﬁxed income. In addition, the Retiree Medical Plan Voluntary Employees’ Beneﬁciary Association (VEBA) considers the effect of income taxes by utilizing a combination of variable annuity and low turnover investment strategies. Members of the EBRC formally review the investment risk and performance of the postretirement plans on a quarterly basis. Future beneﬁts, reﬂecting expected future service that we expect to pay under the pension and other beneﬁt plans, were: (in millions) Pension beneﬁts Non-qualiﬁed Qualiﬁed Other beneﬁts Year ended December 31, 2006 2007 2008 2009 2010 2011-2015 $ 288 315 366 329 339 1,986 $ 24 27 28 34 33 158 $ 54 55 56 57 62 313 Other Expenses Expenses exceeding 1% of total interest income and noninterest income that are not otherwise shown separately in the ﬁnancial statements or Notes to Financial Statements were: (in millions) Outside professional services Contract services Travel and entertainment Outside data processing Advertising and promotion Postage Telecommunications 2005 $835 596 481 449 443 281 278 Year ended December 31, 2003 2004 $669 626 442 418 459 269 296 $509 866 389 404 392 336 343 The weighted-average assumptions used to determine the net periodic beneﬁt cost were: 2005 2004 Other Other Pension Pension beneﬁts(1) beneﬁts beneﬁts(1) beneﬁts Year ended December 31, 2003 Other Pension beneﬁts(1) beneﬁts 6.0% 6.0% 6.5% 6.5% 7.0% 7.0% Discount rate Expected return on plan assets Rate of 9.0 9.0 compensation increase 4.0 — 9.0 4.0 9.0 — 9.0 4.0 9.0 — (1) Includes both qualiﬁed and nonqualiﬁed pension beneﬁts. The long-term rate of return assumptions above were derived based on a combination of factors including (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. To account for postretirement health care plans we use a health care cost trend rate to recognize the effect of expected changes in future health care costs due to medical inﬂation, utilization changes, new technology, regulatory requirements and Medicare cost shifting. We assumed average annual increases of 9.5% for health care costs for 2006. The rate of average annual increases is assumed to trend down 1% each year between 2006 and 2010. By 2010 and thereafter, we assumed rates of 5.5% for HMOs and for all other types of coverage. Increasing the assumed health care trend by one percentage point in each year would increase the beneﬁt obligation as of December 31, 2005, by $52 million and the total of the interest cost and service cost components of the net periodic beneﬁt cost for 2005 by $4 million. Decreasing the assumed health care trend by one percentage point in each year would decrease the beneﬁt obligation as of December 31, 2005, by $48 million and the total of the interest cost and service cost components of the net periodic beneﬁt cost for 2005 by $4 million. 90 Note 16: Income Taxes The components of income tax expense were: (in millions) Current: Federal State and local Foreign Deferred: Federal State and local Total 2005 $2,627 346 91 3,064 715 98 813 $3,877 $2,815 354 154 3,323 379 53 432 $3,755 $1,298 165 114 1,577 1,492 206 1,698 $3,275 The tax beneﬁt related to the exercise of employee stock options recorded in stockholders’ equity was $143 million, $175 million and $148 million for 2005, 2004 and 2003, respectively. We had a net deferred tax liability of $5,595 million and $4,940 million at December 31, 2005 and 2004, respectively. The tax effects of temporary differences that gave rise to signiﬁcant portions of deferred tax assets and liabilities are presented in the table to the right. We have determined that a valuation reserve is not required for any of the deferred tax assets since it is more likely than not that these assets will be realized principally through carry back to taxable income in prior years, future reversals of existing taxable temporary differences, and, to a lesser extent, future taxable income and tax planning strategies. Our conclusion that it is “more likely than not” that the deferred tax assets will be realized is based on federal taxable income in excess of $17 billion in the carry-back period, substantial state taxable income in the carry-back period, as well as a history of growth in earnings. Year ended December 31, 2003 2004 (in millions) December 31, 2004 2005 Deferred Tax Assets Allowance for loan losses Net tax-deferred expenses Other Total deferred tax assets Deferred Tax Liabilities Core deposit intangibles Leasing Mark to market Mortgage servicing FAS 115 adjustment FAS 133 adjustment Other Total deferred tax liabilities $1,471 179 461 2,111 153 2,430 708 3,517 368 29 501 7,706 $1,430 217 402 2,049 188 2,461 448 2,848 535 23 486 6,989 Net Deferred Tax Liability $5,595 $4,940 The deferred tax liability related to 2005, 2004 or 2003 unrealized gains and losses on securities available for sale along with the deferred tax liability related to certain derivative and hedging activities for 2005 and 2004, had no effect on income tax expense as these gains and losses, net of taxes, were recorded in cumulative other comprehensive income. The table below reconciles the statutory federal income tax expense and rate to the effective income tax expense and rate. (in millions) Statutory federal income tax expense and rate Change in tax rate resulting from: State and local taxes on income, net of federal income tax benefit Tax-exempt income and tax credits Donations of appreciated securities Other 2005 Rate Amount 2004 Rate Amount Year ended December 31, 2003 Rate Amount $4,042 35.0% $3,769 35.0% $3,317 35.0% 289 (327) (33) (94) 2.5 (2.8) (.3) (.8) 265 (224) — (55) 2.5 (2.1) — (.5) 241 (161) (90) (32) 2.5 (1.7) (.9) (.3) Effective income tax expense and rate $3,877 33.6% $3,755 34.9% $3,275 34.6% 91 Note 17: Earnings Per Common Share The table below shows earnings per common share and diluted earnings per common share and reconciles the numerator and denominator of both earnings per common share calculations. (in millions, except per share amounts) Net income Less: Preferred stock dividends Net income applicable to common stock (numerator) EARNINGS PER COMMON SHARE Average common shares outstanding (denominator) Per share DILUTED EARNINGS PER COMMON SHARE Average common shares outstanding Add: Stock options Restricted share rights Diluted average common shares outstanding (denominator) Per share At December 31, 2005, 2004 and 2003, options to purchase 4.9 million, 3.3 million and 4.4 million shares, respectively, were outstanding but not included in the calculation of earn- ings per common share because the exercise price was higher than the market price, and therefore they were antidilutive. 2005 $ 7,671 — $ 7,671 1,686.3 $ 4.55 1,686.3 18.9 .3 1,705.5 $ 4.50 2004 $ 7,014 — $ 7,014 1,692.2 $ 4.15 1,692.2 20.8 .4 1,713.4 $ 4.09 Year ended December 31, 2003 $ 6,202 3 $ 6,199 1,681.1 $ 3.69 1,681.1 16.0 .4 1,697.5 $ 3.65 92 Note 18: Other Comprehensive Income The components of other comprehensive income and the related tax effects were: (in millions) 2005 Net of Tax tax effect Before tax Before tax 2004 Net of Tax tax effect Year ended December 31, 2003 Net of tax Tax effect Before tax Translation adjustments $ 8 $ 3 $ 5 $ 20 $ 8 $ 12 $ 42 $ 16 $ 26 Securities available for sale and other retained interests: Net unrealized gains (losses) arising during the year Reclassiﬁcation of gains included in net income Net unrealized losses arising during the year Derivatives and hedging activities: Net unrealized gains (losses) arising during the year Reclassiﬁcation of net losses (gains) on cash ﬂow hedges included in net income Net unrealized gains arising during the year (401) (143) (258) (64) (24) (40) (465) (167) (298) 35 (72) (37) 12 (27) (15) 23 (45) (22) (117) (68) (185) (42) (26) (68) (75) (42) (117) 349 134 215 (376) (137) (239) (1,629) (603) (1,026) (335) (128) (207) 14 6 8 413 37 152 15 8 261 22 1,707 78 628 25 1,079 53 $ 12 $ (65) $ (27) $ (38) Other comprehensive income $(443) $(158) $(285) $ 20 $ Cumulative other comprehensive income balances were: (in millions) Balance, December 31, 2002 Net change Balance, December 31, 2003 Net change Balance, December 31, 2004 Net change Balance, December 31, 2005 Translation adjustments Net unrealized gains (losses) on securities and other retained interests Net unrealized gains (losses) on derivatives and other hedging activities Cumulative other comprehensive income $(14) 26 12 12 $ 24 5 $ 29 $1,030 (117) 913 (22) $ 891 (298) $ 593 $(40) 53 13 22 $ 35 8 $ 43 $ 976 (38) 938 12 $ 950 (285) $ 665 93 Note 19: Operating Segments We have three lines of business for management reporting: Community Banking, Wholesale Banking and Wells Fargo Financial. The results for these lines of business are based on our management accounting process, which assigns balance sheet and income statement items to each responsible operating segment. This process is dynamic and, unlike ﬁnancial accounting, there is no comprehensive, authoritative guidance for management accounting equivalent to generally accepted accounting principles. The management accounting process measures the performance of the operating segments based on our management structure and is not necessarily comparable with similar information for other ﬁnancial services companies. We deﬁne our operating segments by product type and customer segments. If the management structure and/or the allocation process changes, allocations, transfers and assignments may change. To reﬂect the realignment of our automobile ﬁnancing businesses into Wells Fargo Financial in 2005, segment results for prior periods have been revised. The Community Banking Group offers a complete line of banking and diversiﬁed ﬁnancial products and services to consumers and small businesses with annual sales generally up to $20 million in which the owner generally is the ﬁnancial decision maker. Community Banking also offers investment management and other services to retail customers and high net worth individuals, insurance, securities brokerage through afﬁliates and venture capital ﬁnancing. These products and services include the Wells Fargo Advantage FundsSM, a family of mutual funds, as well as personal trust and agency assets. Loan products include lines of credit, equity lines and loans, equipment and transportation (recreational vehicle and marine) loans, education loans, origination and purchase of residential mortgage loans and servicing of mortgage loans and credit cards. Other credit products and ﬁnancial services available to small businesses and their owners include receivables and inventory ﬁnancing, equipment leases, real estate ﬁnancing, Small Business Administration ﬁnancing, venture capital ﬁnancing, cash management, payroll services, retirement plans, Health Savings Accounts and credit and debit card processing. Consumer and business deposit products include checking accounts, savings deposits, market rate accounts, Individual Retirement Accounts (IRAs), time deposits and debit cards. Community Banking serves customers through a wide range of channels, which include traditional banking stores, in-store banking centers, business centers and ATMs. Also, Phone BankSM centers and the National Business Banking Center provide 24-hour telephone service. Online banking services include single sign-on to online banking, bill pay and brokerage, as well as online banking for small business. 94 The Wholesale Banking Group serves businesses across the United States with annual sales generally in excess of $10 million. Wholesale Banking provides a complete line of commercial, corporate and real estate banking products and services. These include traditional commercial loans and lines of credit, letters of credit, asset-based lending, equipment leasing, mezzanine ﬁnancing, high-yield debt, international trade facilities, foreign exchange services, treasury management, investment management, institutional ﬁxed income and equity sales, interest rate, commodity and equity risk management, online/electronic products such as the Commercial Electronic Ofﬁce® (CEO®) portal, insurance brokerage services and investment banking services. Wholesale Banking manages and administers institutional investments, employee beneﬁt trusts and mutual funds, including the Wells Fargo Advantage Funds. Wholesale Banking includes the majority ownership interest in the Wells Fargo HSBC Trade Bank, which provides trade ﬁnancing, letters of credit and collection services and is sometimes supported by the Export-Import Bank of the United States (a public agency of the United States offering export ﬁnance support for American-made products). Wholesale Banking also supports the commercial real estate market with products and services such as construction loans for commercial and residential development, land acquisition and development loans, secured and unsecured lines of credit, interim ﬁnancing arrangements for completed structures, rehabilitation loans, affordable housing loans and letters of credit, permanent loans for securitization, commercial real estate loan servicing and real estate and mortgage brokerage services. Wells Fargo Financial includes consumer ﬁnance and auto ﬁnance operations. Consumer ﬁnance operations make direct consumer and real estate loans to individuals and purchase sales ﬁnance contracts from retail merchants from ofﬁces throughout the United States and in Canada, Latin America, the Caribbean, Guam and Saipan. Automobile ﬁnance oper- ations specialize in purchasing sales ﬁnance contracts directly from automobile dealers and making loans secured by auto- mobiles in the United States, Canada and Puerto Rico. Wells Fargo Financial also provides credit cards and lease and other commercial ﬁnancing. The “Other” Column consists of unallocated goodwill balances held at the enterprise level. This column also may include separately identiﬁed transactions recorded at the enterprise level for management reporting. (income/expense in millions, average balances in billions) 2005 Net interest income (1) Provision for credit losses Noninterest income Noninterest expense Income before income tax expense Income tax expense Net income 2004 Net interest income (1) Provision for credit losses Noninterest income Noninterest expense Income (loss) before income tax expense (beneﬁt) Income tax expense (beneﬁt) Net income (loss) 2003 Net interest income (1) Provision for credit losses Noninterest income Noninterest expense Income (loss) before income tax expense (beneﬁt) Income tax expense (beneﬁt) Net income (loss) 2005 Average loans Average assets Average core deposits 2004 Average loans Average assets Average core deposits Community Banking Wholesale Banking Wells Fargo Financial Other (2) Consolidated Company $12,708 895 9,822 13,294 8,341 2,812 $ 5,529 $ 12,019 787 8,670 12,312 7,590 2,678 $ 4,912 $ 11,360 817 8,336 12,332 6,547 2,259 $ 4,288 $ 187.0 298.6 218.2 $ 178.9 284.2 197.8 $2,387 1 3,352 3,165 2,573 840 $1,733 $ 2,209 62 2,974 2,728 2,393 794 $ 1,599 $ 2,228 177 2,707 2,579 2,179 733 $ 1,446 $ 62.2 88.7 24.6 $ 53.1 77.6 25.5 $3,409 1,487 1,271 2,559 634 225 $ — — — — — — $ 409 $ — $ 2,922 868 1,265 2,357 962 345 $ 617 $ 2,435 698 1,339 2,228 848 317 $ 531 $ 46.9 52.7 — $ 37.6 43.0 .1 $ — — — 176 (176) (62) $(114) $ (16) 30 — 51 (97) (34) $ (63) $ — 5.8 — $ — 5.8 — $18,504 2,383 14,445 19,018 11,548 3,877 $ 7,671 $ 17,150 1,717 12,909 17,573 10,769 3,755 $ 7,014 $ 16,007 1,722 12,382 17,190 9,477 3,275 $ 6,202 $ 296.1 445.8 242.8 $ 269.6 410.6 223.4 (1) Net interest income is the difference between interest earned on assets and the cost of liabilities to fund those assets. Interest earned includes actual interest earned on segment assets and, if the segment has excess liabilities, interest credits for providing funding to other segments. The cost of liabilities includes interest expense on segment liabilities and, if the segment does not have enough liabilities to fund its assets, a funding charge based on the cost of excess liabilities from another segment. In general, Community Banking has excess liabilities and receives interest credits for the funding it provides the other segments. (2) The items recorded at the enterprise level included a $176 million loss on debt extinguishment for 2004 and a $30 million non-recurring loss on sale of a sub-prime credit card portfolio and $51 million of other charges related to employee beneﬁts and software for 2003. 95 Note 20: Securitizations and Variable Interest Entities We also retained some AAA-rated ﬂoating-rate mortgage- backed securities. The fair value at the date of securitization was determined using quoted market prices. The implied CPR, life, and discount spread to the London Interbank Offered Rate (LIBOR) curve at the date of securitization is presented in the following table. Prepayment speed (annual CPR) Life (in years) Discount spread to LIBOR curve Retained interest – AAA mortgage-backed securities 2004 2005 26.8% 2.4 .22% 34.8% 2.2 .32% Key economic assumptions and the sensitivity of the current fair value to immediate adverse changes in those assumptions at December 31, 2005, for mortgage servicing rights, both purchased and retained, and other retained interests related to residential mortgage loan securitizations are presented in the following table. ($ in millions) Mortgage Other retained interests servicing rights Fair value of retained interests Expected weighted-average life (in years) $12,687 5.8 $ 223 6.4 Prepayment speed assumption (annual CPR) 11.6% 8.6% Decrease in fair value from 10% adverse change Decrease in fair value from 25% adverse change $ 441 $ 7 1,032 17 Discount rate assumption 10.5% 10.5% Decrease in fair value from 100 basis point adverse change Decrease in fair value from 200 basis point adverse change $ 476 $ 7 916 14 Key economic assumptions and the sensitivity of the current fair value to immediate adverse changes in those assumptions at December 31, 2005, for the AAA-rated ﬂoating-rate mortgage-backed securities related to residential mortgage loan securitizations are presented in the table on the next page. The fair value of these securities was determined using quoted market prices. We routinely originate, securitize and sell into the secondary market home mortgage loans and, from time to time, other ﬁnancial assets, including student loans, commercial mortgage loans, home equity loans, auto receivables and securities. We typically retain the servicing rights and may retain other beneﬁcial interests from these sales. Through these securitizations, which are structured without recourse to us and with no restrictions on the retained interests, we may be exposed to a liability under standard representations and warranties we make to purchasers and issuers. The amount recorded for this liability was not material to our consolidated ﬁnancial statements at year-end 2005 or 2004. We do not have signiﬁcant credit risks from the retained interests. We recognized gains of $326 million from sales of ﬁnancial assets in securitizations in 2005 and $199 million in 2004. Additionally, we had the following cash ﬂows with our securitization trusts. (in millions) Mortgage 2005 Other loans ﬁnancial assets Year ended December 31, 2004 Other ﬁnancial assets Mortgage loans Sales proceeds from securitizations Servicing fees Cash flows on other retained interests $40,982 154 $225 — $33,550 88 560 6 138 $ — — 11 In the normal course of creating securities to sell to investors, we may sponsor special-purpose entities that hold, for the beneﬁt of the investors, ﬁnancial instruments that are the source of payment to the investors. Special-purpose entities are consolidated unless they meet the criteria for a qualifying special-purpose entity in accordance with FAS 140 or are not required to be consolidated under existing accounting guidance. For securitizations completed in 2005 and 2004, we used the following assumptions to determine the fair value of mortgage servicing rights and other retained interests at the date of securitization. Prepayment speed (annual CPR (1)) (2) Life (in years) (2) Discount rate (2) Mortgage servicing rights 2004 2005 Other retained interests 2004 2005 16.9% 16.8% 5.6 4.9 10.1% 9.9% 12.7% 14.9% 7.0 3.9 10.2% 10.3% (1) Constant prepayment rate. (2) Represents weighted averages for all retained interests resulting from securitizations completed in 2005 and 2004. 96 ($ in millions) Retained interest – AAA mortgage- backed securities Fair value of retained interests Expected weighted-average life (in years) Prepayment speed assumption (annual CPR) Decrease in fair value from 10% adverse change Decrease in fair value from 25% adverse change Discount spread to LIBOR curve assumption Decrease in fair value from 10 basis point adverse change Decrease in fair value from 20 basis point adverse change $3,358 2.2 28.1% $ — — $ .22% 7 14 The sensitivities in the previous tables are hypothetical and should be relied on with caution. Changes in fair value based on a 10% variation in assumptions generally cannot be extrapolated because the relationship of the change in the assumption to the change in fair value may not be linear. Also, in the previous tables, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated independently without changing any other assumption. In reality, changes in one factor may result in changes in another (for example, changes in prepayment speed estimates could result in changes in the discount rates), which might magnify or counteract the sensitivities. This table presents information about the principal balances of owned and securitized loans. (in millions) Commercial and commercial real estate: Commercial Other real estate mortgage Real estate construction Lease ﬁnancing Total commercial and commercial real estate Consumer: Real estate 1-4 family first mortgage Real estate 1-4 family junior lien mortgage Credit card Other revolving credit and installment Total consumer Foreign Less: Total loans owned and securitized Securitized loans Mortgages held for sale Loans held for sale Total loans held December 31, Total loans (1) Delinquent loans (2) 2005 2004 2005 2004 Year ended December 31, Net charge-offs (recoveries) 2004 2005 $ 304 $ 371 370 63 68 872 344 40 45 733 709 194 159 470 1,532 71 724 132 150 476 1,482 99 $ 273 11 (7) 14 291 $ 274 32 (1) 36 341 90 105 467 1,115 1,777 239 47 83 401 699 1,230 122 $2,336 $2,453 $2,307 $1,693 $ 61,552 45,042 13,406 5,400 125,400 $ 54,517 48,402 9,025 5,169 117,113 136,261 59,143 12,009 48,287 255,700 5,930 387,030 35,047 40,534 612 132,703 52,190 10,260 43,744 238,897 4,527 360,537 34,489 29,723 8,739 $ 310,837 $287,586 (1) Represents loans on the balance sheet or that have been securitized, but excludes securitized loans that we continue to service but as to which we have no other continuing involvement. (2) Includes nonaccrual loans and loans 90 days or more past due and still accruing. We are a variable interest holder in certain special-purpose entities that are consolidated because we absorb a majority of each entity’s expected losses, receive a majority of each entity’s expected returns or both. We do not hold a majority voting interest in these entities. Our consolidated variable interest entities (VIEs), substantially all of which were formed to invest in securities and to securitize real estate investment trust securities, had approximately $2.5 billion and $6 billion in total assets at December 31, 2005 and 2004, respectively. The primary activities of these entities consist of acquiring and disposing of, and investing and reinvesting in securities, and issuing beneﬁcial interests secured by those securities to investors. The creditors of most of these consolidated entities have no recourse against us. We also hold variable interests greater than 20% but less than 50% in certain special-purpose entities formed to provide affordable housing and to securitize corporate debt that had approximately $3 billion in total assets at December 31, 2005 and 2004. We are not required to consolidate these entities. Our maximum exposure to loss as a result of our involvement with these unconsolidated variable interest entities was approximately $870 million and $950 million at December 31, 2005 and 2004, respectively, predominantly representing investments in entities formed to invest in affordable housing. We, however, expect to recover our investment over time primarily through realization of federal low-income housing tax credits. 97 Note 21: Mortgage Banking Activities Mortgage banking activities, included in the Community Banking and Wholesale Banking operating segments, consist of residential and commercial mortgage originations and servicing. The components of mortgage banking noninterest income were: (in millions) Servicing income, net: Servicing fees (1) Amortization Reversal of provision (provision) for mortgage servicing rights in excess of fair value Net derivative gains (losses): Fair value hedges (2) Other (3) Total servicing income, net Net gains on mortgage loan origination/sales activities All other Total mortgage banking noninterest income Year ended December 31, 2003 2004 2005 $ 2,457 (1,991) $ 2,101 (1,826) $ 1,787 (2,760) 378 (46) 189 987 1,085 350 208 554 — 1,037 539 284 (1,092) 1,111 — (954) 3,019 447 The changes in mortgage servicing rights were: (in millions) Mortgage servicing rights: Balance, beginning of year Originations (1) Purchases (1) Amortization Write-down Other (includes changes in mortgage servicing rights due to hedging) Balance, end of year Valuation allowance: Balance, beginning of year Provision (reversal of provision) for mortgage servicing rights in excess of fair value Write-down of mortgage servicing rights Year ended December 31, 2003 2004 2005 $ 9,466 2,652 2,683 (1,991) — $ 8,848 1,769 1,353 (1,826) (169) $ 6,677 3,546 2,140 (2,760) (1,338) 888 $13,698 (509) $ 9,466 583 $ 8,848 $ 1,565 $ 1,942 $ 2,188 (378) (208) 1,092 — (169) (1,338) Balance, end of year $ 1,187 $ 1,565 $ 1,942 $ 2,422 $ 1,860 $ 2,512 Mortgage servicing rights, net $12,511 $ 7,901 $ 6,906 Ratio of mortgage servicing rights to related loans serviced for others 1.44% 1.15% 1.15% (1) Based on December 31, 2005, assumptions, the weighted-average amortization period for mortgage servicing rights added during the year was approximately 5.6 years. The components of our managed servicing portfolio were: (in billions) Loans serviced for others (1) Owned loans serviced (2) Total owned servicing Sub-servicing Total managed servicing portfolio December 31, 2004 2005 $ 871 118 989 27 $1,016 $688 117 805 27 $832 (1) Consists of 1-4 family ﬁrst mortgage and commercial mortgage loans. (2) Consists of mortgages held for sale and 1-4 family ﬁrst mortgage loans. (1) Includes impairment write-downs on other retained interests of $79 million for 2003. There were no impairment write-downs on other retained interests for 2005 and 2004. (2) Results related to mortgage servicing rights fair value hedging activities consist of gains (losses) excluded from the evaluation of hedge effectiveness and the ineffective portion of the change in the value of these derivatives. Gains and losses excluded from the evaluation of hedge effectiveness are those caused by market conditions (volatility) and the spread between spot and forward rates priced into the derivative contracts (the passage of time). See Note 26 – Fair Value Hedges for additional discussion and detail. (3) Other consists of results from free-standing derivatives used to economically hedge the risk of changes in fair value of mortgage servicing rights. See Note 26 – Free-Standing Derivatives for additional discussion and detail. At the end of each quarter, we evaluate MSRs for possible impairment based on the difference between the carrying amount and current fair value of the MSRs by risk stratiﬁcation. If a temporary impairment exists, we establish a valuation allowance for any excess of amortized cost, as adjusted for hedge accounting, over the current fair value through a charge to income. We have a policy of reviewing MSRs for other-than-temporary impairment each quarter and recognize a direct write-down when the recoverability of a recorded valuation allowance is determined to be remote. Unlike a valuation allowance, a direct write-down permanently reduces the carrying value of the MSRs and the valuation allowance, precluding subsequent reversals. (See Note 1 – Transfers and Servicing of Financial Assets for additional discussion of our policy for valuation of MSRs.) 98 Note 22: Condensed Consolidating Financial Statements Following are the condensed consolidating ﬁnancial statements of the Parent and Wells Fargo Financial, Inc. and its wholly-owned subsidiaries (WFFI). The Wells Fargo Financial business segment for management reporting Condensed Consolidating Statement of Income (see Note 19) consists of WFFI and other afﬁliated consumer ﬁnance entities managed by WFFI that are included within other consolidating subsidiaries in the following tables. (in millions) Parent WFFI Other consolidating subsidiaries Eliminations Consolidated Company Year ended December 31, 2005 Dividends from subsidiaries: Bank Nonbank Interest income from loans Interest income from subsidiaries Other interest income Total interest income Deposits Short-term borrowings Long-term debt Total interest expense NET INTEREST INCOME Provision for credit losses Net interest income after provision for credit losses NONINTEREST INCOME Fee income – nonafﬁliates Other Total noninterest income NONINTEREST EXPENSE Salaries and beneﬁts Other Total noninterest expense INCOME BEFORE INCOME TAX EXPENSE (BENEFIT) AND EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARIES Income tax expense (beneﬁt) Equity in undistributed income of subsidiaries NET INCOME $4,675 763 — 2,215 105 7,758 — 256 2,000 2,256 5,502 — 5,502 — 298 298 92 50 142 5,658 145 2,158 $7,671 $ — — 4,467 — 104 4,571 — 223 1,362 1,585 2,986 1,582 1,404 224 223 447 985 759 1,744 107 (2) — $ 109 $ — — 16,809 — 4,493 21,302 3,848 897 598 5,343 15,959 801 15,158 8,111 5,727 13,838 9,378 8,398 17,776 11,220 3,734 — $ 7,486 $(4,675) (763) (16) (2,215) — (7,669) — (632) (1,094) (1,726) (5,943) — (5,943) — (138) (138) — (644) (644) (5,437) — (2,158) $(7,595) $ — — 21,260 — 4,702 25,962 3,848 744 2,866 7,458 18,504 2,383 16,121 8,335 6,110 14,445 10,455 8,563 19,018 11,548 3,877 — $ 7,671 99 Condensed Consolidating Statements of Income (in millions) Parent WFFI Other consolidating subsidiaries Eliminations Consolidated Company Year ended December 31, 2004 Dividends from subsidiaries: Bank Nonbank Interest income from loans Interest income from subsidiaries Other interest income Total interest income Deposits Short-term borrowings Long-term debt Total interest expense NET INTEREST INCOME Provision for credit losses Net interest income after provision for credit losses NONINTEREST INCOME Fee income – nonafﬁliates Other Total noninterest income NONINTEREST EXPENSE Salaries and beneﬁts Other Total noninterest expense INCOME BEFORE INCOME TAX EXPENSE (BENEFIT) AND EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARIES Income tax expense (beneﬁt) Equity in undistributed income of subsidiaries NET INCOME Year ended December 31, 2003 Dividends from subsidiaries: Bank Nonbank Interest income from loans Interest income from subsidiaries Other interest income Total interest income Short-term borrowings Long-term debt Other interest expense Total interest expense NET INTEREST INCOME Provision for credit losses Net interest income after provision for credit losses NONINTEREST INCOME Fee income – nonafﬁliates Other Total noninterest income NONINTEREST EXPENSE Salaries and beneﬁts Other Total noninterest expense INCOME BEFORE INCOME TAX EXPENSE (BENEFIT) AND EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARIES Income tax expense (beneﬁt) Equity in undistributed income of subsidiaries NET INCOME 100 $3,652 307 — 1,117 91 5,167 — 106 872 978 4,189 — 4,189 — 139 139 64 313 377 3,951 (97) 2,966 $7,014 $5,194 841 2 567 75 6,679 81 560 — 641 6,038 — 6,038 — 167 167 134 18 152 6,053 (48) 101 $6,202 $ — — 3,548 — 84 3,632 — 47 1,089 1,136 2,496 833 1,663 223 256 479 944 746 1,690 452 159 — $ 293 $ — — 2,799 — 77 2,876 73 730 — 803 2,073 814 1,259 209 239 448 745 583 1,328 379 143 — $ 236 $ — — 13,233 — 4,011 17,244 1,827 458 387 2,672 14,572 884 13,688 7,319 5,053 12,372 7,916 7,820 15,736 10,324 3,693 — $ 6,631 $ — — 11,136 — 5,329 16,465 413 321 1,734 2,468 13,997 908 13,089 6,664 5,195 11,859 7,567 8,301 15,868 9,080 3,180 — $ 5,900 $(3,652) (307) — (1,117) — (5,076) — (258) (711) (969) (4,107) — (4,107) — (81) (81) — (230) (230) (3,958) — (2,966) $(6,924) $(5,194) (841) — (567) — (6,602) (245) (256) — (501) (6,101) — (6,101) — (92) (92) — (158) (158) (6,035) — (101) $(6,136) $ — — 16,781 — 4,186 20,967 1,827 353 1,637 3,817 17,150 1,717 15,433 7,542 5,367 12,909 8,924 8,649 17,573 10,769 3,755 — $ 7,014 $ — — 13,937 — 5,481 19,418 322 1,355 1,734 3,411 16,007 1,722 14,285 6,873 5,509 12,382 8,446 8,744 17,190 9,477 3,275 — $ 6,202 Condensed Consolidating Balance Sheets (in millions) Parent WFFI Other consolidating subsidiaries Eliminations Consolidated Company December 31, 2005 ASSETS Cash and cash equivalents due from: Subsidiary banks Nonafﬁliates Securities available for sale Mortgages and loans held for sale Loans Loans to subsidiaries: Bank Nonbank Allowance for loan losses Net loans Investments in subsidiaries: Bank Nonbank Other assets Total assets LIABILITIES AND STOCKHOLDERS’ EQUITY Deposits Short-term borrowings Accrued expenses and other liabilities Long-term debt Indebtedness to subsidiaries Total liabilities Stockholders’ equity Total liabilities and stockholders’ equity December 31, 2004 ASSETS Cash and cash equivalents due from: Subsidiary banks Nonafﬁliates Securities available for sale Mortgages and loans held for sale Loans Loans to subsidiaries: Bank Nonbank Allowance for loan losses Net loans Investments in subsidiaries: Bank Nonbank Other assets Total assets LIABILITIES AND STOCKHOLDERS’ EQUITY Deposits Short-term borrowings Accrued expenses and other liabilities Long-term debt Indebtedness to subsidiaries Total liabilities Stockholders’ equity Total liabilities and stockholders’ equity $ 10,720 74 888 — 1 3,100 44,935 — 48,036 37,298 4,258 6,272 $107,546 $ — 81 3,480 59,341 3,984 66,886 40,660 $107,546 $ 9,493 226 1,419 — 1 700 36,368 — 37,069 35,357 4,413 4,720 $ 92,697 $ — 65 2,535 50,146 2,085 54,831 37,866 $ 92,697 $ 255 219 1,763 32 44,598 — 1,003 (1,280) 44,321 — — 1,247 $47,837 $ — 9,005 1,241 35,087 — 45,333 2,504 $47,837 $ 171 311 1,841 23 33,624 — 856 (952) 33,528 — — 807 $36,681 $ — 5,662 1,103 27,508 — 34,273 2,408 $36,681 $ 25 20,410 39,189 41,114 267,121 — — (2,591) 264,530 — — 65,336 $430,604 $325,450 28,746 20,856 16,613 — 391,665 38,939 $430,604 $ — 17,386 30,463 38,439 253,961 — — (2,810) 251,151 — — 48,997 $386,436 $284,522 27,985 17,342 19,354 — 349,203 37,233 $386,436 $ (11,000) — (6) — (883) (3,100) (45,938) — (49,921) (37,298) (4,258) (1,763) $(104,246) $ (11,000) (13,940) (2,506) (31,373) (3,984) (62,803) (41,443) $(104,246) $ (9,664) — (6) — — (700) (37,224) — (37,924) (35,357) (4,413) (601) $ (87,965) $ (9,664) (11,750) (1,397) (23,428) (2,085) (48,324) (39,641) $ (87,965) $ — 20,703 41,834 41,146 310,837 — — (3,871) 306,966 — — 71,092 $481,741 $314,450 23,892 23,071 79,668 — 441,081 40,660 $481,741 $ — 17,923 33,717 38,462 287,586 — — (3,762) 283,824 — — 53,923 $427,849 $274,858 21,962 19,583 73,580 — 389,983 37,866 $427,849 101 Condensed Consolidating Statement of Cash Flows (in millions) Parent WFFI Other consolidating subsidiaries/ eliminations Consolidated Company $ 5,396 $ 1,159 $(15,888) $ (9,333) 631 90 (231) — — — — — — (3,166) (10,751) 2,950 194 — (10,283) — 1,048 18,297 (8,216) 1,367 (3,159) (3,375) — 5,962 1,075 9,719 281 248 (486) — (953) 232 — 19,542 (29,757) — — — — (1,059) (11,952) — 3,344 11,891 (4,450) — — — — 10,785 (8) 482 474 $ 10,794 $ 18,147 6,634 (27,917) 66 (41,356) 42,007 (8,853) 3,280 (3,918) 3,166 10,751 (2,950) (194) (6,697) (7,834) 38,961 (2,514) (3,715) (5,910) — — — (1,673) 25,149 1,427 2,702 19,059 6,972 (28,634) 66 (42,309) 42,239 (8,853) 22,822 (33,675) — — — — (7,756) (30,069) 38,961 1,878 26,473 (18,576) 1,367 (3,159) (3,375) (1,673) 41,896 2,494 12,903 $ 4,129 $ 15,397 Year ended December 31, 2005 Cash flows from operating activities: Net cash provided (used) by operating activities Cash flows from investing activities: Securities available for sale: Sales proceeds Prepayments and maturities Purchases Net cash acquired from acquisitions Increase in banking subsidiaries’ loan originations, net of collections Proceeds from sales (including participations) of loans by banking subsidiaries Purchases (including participations) of loans by banking subsidiaries Principal collected on nonbank entities’ loans Loans originated by nonbank entities Net advances to nonbank entities Capital notes and term loans made to subsidiaries Principal collected on notes/loans made to subsidiaries Net decrease (increase) in investment in subsidiaries Other, net Net cash used by investing activities Cash flows from financing activities: Net increase in deposits Net increase (decrease) in short-term borrowings Proceeds from issuance of long-term debt Long-term debt repayment Proceeds from issuance of common stock Common stock repurchased Cash dividends paid on common stock Other, net Net cash provided by ﬁnancing activities Net change in cash and due from banks Cash and due from banks at beginning of year Cash and due from banks at end of year 102 Condensed Consolidating Statement of Cash Flows (in millions) Parent WFFI Other consolidating subsidiaries/ eliminations Consolidated Company Year ended December 31, 2004 Cash flows from operating activities: Net cash provided by operating activities Cash flows from investing activities: Securities available for sale: Sales proceeds Prepayments and maturities Purchases Net cash paid for acquisitions Increase in banking subsidiaries’ loan originations, net of collections Proceeds from sales (including participations) of loans by banking subsidiaries Purchases (including participations) of loans by banking subsidiaries Principal collected on nonbank entities’ loans Loans originated by nonbank entities Net advances to nonbank entities Capital notes and term loans made to subsidiaries Principal collected on notes/loans made to subsidiaries Net decrease (increase) in investment in subsidiaries Other, net Net cash used by investing activities Cash flows from financing activities: Net increase (decrease) in deposits Net increase (decrease) in short-term borrowings Proceeds from issuance of long-term debt Long-term debt repayment Proceeds from issuance of common stock Common stock repurchased Cash dividends paid on common stock Other, net Net cash provided by ﬁnancing activities Net change in cash and due from banks Cash and due from banks at beginning of year Cash and due from banks at end of year $ 3,848 $ 1,297 $ 1,340 $ 6,485 78 160 (207) — — — — — — (92) (11,676) 896 (353) — (11,194) — (831) 19,610 (4,452) 1,271 (2,188) (3,150) — 10,260 2,914 6,805 268 152 (580) — — — — 17,668 (27,778) — — — — (121) (10,391) (110) 683 12,919 (4,077) — — — — 9,415 321 161 482 $ 9,719 $ 5,976 8,511 (15,796) (331) (33,800) 14,540 (5,877) 328 27 92 11,676 (896) 353 (2,652) (17,849) 27,437 (2,549) (3,135) (11,110) — — — (13) 10,630 (5,879) 8,581 6,322 8,823 (16,583) (331) (33,800) 14,540 (5,877) 17,996 (27,751) — — — — (2,773) (39,434) 27,327 (2,697) 29,394 (19,639) 1,271 (2,188) (3,150) (13) 30,305 (2,644) 15,547 $ 2,702 $ 12,903 103 Condensed Consolidating Statement of Cash Flows (in millions) Parent WFFI Other consolidating subsidiaries/ eliminations Consolidated Company Year ended December 31, 2003 Cash flows from operating activities: Net cash provided by operating activities Cash flows from investing activities: Securities available for sale: Sales proceeds Prepayments and maturities Purchases Net cash paid for acquisitions Increase in banking subsidiaries’ loan originations, net of collections Proceeds from sales (including participations) of loans by banking subsidiaries Purchases (including participations) of loans by banking subsidiaries Principal collected on nonbank entities’ loans Loans originated by nonbank entities Purchases of loans by nonbank entities Net advances to nonbank entities Capital notes and term loans made to subsidiaries Principal collected on notes/loans made to subsidiaries Net decrease (increase) in investment in subsidiaries Other, net Net cash used by investing activities Cash flows from financing activities: Net increase in deposits Net decrease in short-term borrowings Proceeds from issuance of long-term debt Long-term debt repayment Proceeds from issuance of guaranteed preferred beneﬁcial interests in Company’s subordinated debentures Proceeds from issuance of common stock Preferred stock redeemed Common stock repurchased Cash dividends paid on preferred and common stock Other, net Net cash provided by ﬁnancing activities Net change in cash and due from banks Cash and due from banks at beginning of year Cash and due from banks at end of year Note 23: Legal Actions $ 6,352 $ 1,271 $ 23,572 $ 31,195 146 150 (655) (55) — — — 3,683 — (3,682) (2,570) (14,614) 6,160 122 — (11,315) — (1,182) 15,656 (3,425) 700 944 (73) (1,482) (2,530) — 8,608 3,645 3,160 347 223 (732) (600) — — — 13,335 (21,035) — — — — — 107 (8,355) 22 (676) 10,355 (2,151) — — — — (600) — 6,950 (134) 295 $ 6,805 $ 161 6,864 12,779 (23,744) (167) (36,235) 1,590 (15,087) 620 (757) — 2,570 14,614 (6,160) (122) (74) (43,309) 28,621 (7,043) 3,479 (12,355) — — — — 600 651 13,953 (5,784) 14,365 $ 8,581 7,357 13,152 (25,131) (822) (36,235) 1,590 (15,087) 17,638 (21,792) (3,682) — — — — 33 (62,979) 28,643 (8,901) 29,490 (17,931) 700 944 (73) (1,482) (2,530) 651 29,511 (2,273) 17,820 $ 15,547 In the normal course of business, we are subject to pending and threatened legal actions, some for which the relief or damages sought are substantial. After reviewing pending and threatened actions with counsel, and any speciﬁc reserves established for such matters, management believes that the outcome of such actions will not have a material adverse effect on the results of operations or stockholders’ equity. We are not able to predict whether the outcome of such actions may or may not have a material adverse effect on results of operations in a particular future period as the timing and amount of any resolution of such actions and its relationship to the future results of operations are not known. 104 Note 24: Guarantees We provide signiﬁcant guarantees to third parties including standby letters of credit, various indemniﬁcation agreements, guarantees accounted for as derivatives, contingent consider- ation related to business combinations and contingent performance guarantees. We issue standby letters of credit, which include performance and ﬁnancial guarantees, for customers in connection with contracts between the customers and third parties. Standby letters of credit assure that the third parties will receive speciﬁed funds if customers fail to meet their contractual obligations. We are obliged to make payment if a customer defaults. Standby letters of credit were $10.9 billion at December 31, 2005, and $9.4 billion at December 31, 2004, including ﬁnancial guarantees of $6.4 billion and $5.3 billion, respectively, that we had issued or purchased participations in. Standby letters of credit are net of participations sold to other institutions of $2.1 billion at December 31, 2005, and $1.7 billion at December 31, 2004. We consider the credit risk in standby letters of credit in determining the allowance for credit losses. Deferred fees for these standby letters of credit were not signiﬁcant to our ﬁnancial statements. We also had commitments for commercial and similar letters of credit of $761 million at December 31, 2005, and $731 million at December 31, 2004. At December 31, 2004, we also provided a back-up liquidity facility to a commercial paper conduit that we considered to be a ﬁnancial guarantee. This credit facility, which was terminated in 2005, would have required us to advance, under certain conditions, up to $860 million at December 31, 2004. This back-up liquidity facility was included within our commercial loan commitments at December 31, 2004, and was substantially collateralized in the event it was drawn upon. We enter into indemniﬁcation agreements in the ordinary course of business under which we agree to indemnify third parties against any damages, losses and expenses incurred in connection with legal and other proceedings arising from relationships or transactions with us. These relationships or transactions include those arising from service as a director or ofﬁcer of the Company, underwriting agreements relating to our securities, securities lending, acquisition agreements, and various other business transactions or arrangements. Because the extent of our obligations under these agreements depends entirely upon the occurrence of future events, our potential future liability under these agreements is not determinable. We write options, ﬂoors and caps. Options are exercisable based on favorable market conditions. Periodic settlements occur on ﬂoors and caps based on market conditions. The fair value of the written options liability in our balance sheet was $563 million at December 31, 2005, and $374 million at December 31, 2004. The aggregate written ﬂoors and caps liability was $169 million and $227 million, respectively. Our ultimate obligation under written options, ﬂoors and caps is based on future market conditions and is only quantiﬁable at settlement. The notional value related to written options was $45.5 billion at December 31, 2005, and $29.7 billion at December 31, 2004, and the aggregate notional value related to written ﬂoors and caps was $24.3 billion and $34.7 billion, respectively. We offset substantially all options written to customers with purchased options. We also enter into credit default swaps under which we buy loss protection from or sell loss protection to a counterparty in the event of default of a reference obligation. The carrying amount of the contracts sold was a liability of $6 million at December 31, 2005, and $2 million at December 31, 2004. The maximum amount we would be required to pay under the swaps in which we sold protection, assuming all reference obligations default at a total loss, without recoveries, was $2.7 billion and $2.6 billion based on notional value at December 31, 2005 and 2004, respectively. We purchased credit default swaps of comparable notional amounts to mitigate the exposure of the written credit default swaps at December 31, 2005 and 2004. These purchased credit default swaps had terms (i.e., used the same reference obligation and maturity) that would offset our exposure from the written default swap contracts in which we are providing protection to a counterparty. In connection with certain brokerage, asset management and insurance agency acquisitions we have made, the terms of the acquisition agreements provide for deferred payments or additional consideration based on certain performance targets. At December 31, 2005 and 2004, the amount of contingent consideration we expected to pay was not signiﬁcant to our ﬁnancial statements. We have entered into various contingent performance guarantees through credit risk participation arrangements with remaining terms ranging from one to 24 years. We will be required to make payments under these guarantees if a customer defaults on its obligation to perform under certain credit agreements with third parties. Because the extent of our obligations under these guarantees depends entirely on future events, our potential future liability under these agreements is not fully determinable. However, our exposure under most of the agreements can be quantiﬁed and for those agreements our exposure was contractually limited to an aggregate liability of approximately $110 million at December 31, 2005, and $370 million at December 31, 2004. 105 Note 25: Regulatory and Agency Capital Requirements The Company and each of its subsidiary banks are subject to various regulatory capital adequacy requirements administered by the Federal Reserve Board (FRB) and the OCC, respectively. The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) required that the federal regulatory agencies adopt regulations deﬁning ﬁve capital tiers for banks: well capitalized, adequately capitalized, undercapitalized, signiﬁcantly undercapitalized and critically undercapitalized. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our ﬁnancial statements. Quantitative measures, established by the regulators to ensure capital adequacy, require that the Company and each of the subsidiary banks maintain minimum ratios (set forth in the table below) of capital to risk-weighted assets. There are three categories of capital under the guidelines. Tier 1 capital includes common stockholders’ equity, qualifying preferred stock and trust preferred securities, less goodwill and certain other deductions (including a portion of servicing assets and the unrealized net gains and losses, after taxes, on securities available for sale). Tier 2 capital includes preferred stock not qualifying as Tier 1 capital, subordinated debt, the allowance for credit losses and net unrealized gains on marketable equity securities, subject to limitations by the guidelines. Tier 2 capital is limited to the amount of Tier 1 capital (i.e., at least half of the total capital must be in the form of Tier 1 capital). Tier 3 capital includes certain qualifying unsecured subordinated debt. We do not consolidate our wholly-owned trusts (the Trusts) formed solely to issue trust preferred securities. The amount (in billions) of trust preferred securities issued by the Trusts that was includable in Tier 1 capital in accordance with FRB risk- based capital guidelines was $4.2 billion at December 31, 2005. The junior subordinated debentures held by the Trusts were included in the Company’s long-term debt. (See Note 12.) Under the guidelines, capital is compared with the relative risk related to the balance sheet. To derive the risk included in the balance sheet, a risk weighting is applied to each balance sheet asset and off-balance sheet item, primarily based on the relative credit risk of the counterparty. For example, claims guaranteed by the U.S. government or one of its agencies are risk-weighted at 0% and certain real estate related loans risk-weighted at 50%. Off-balance sheet items, such as loan commitments and derivatives, are also applied a risk weight after calculating balance sheet equivalent amounts. A credit conversion factor is assigned to loan commitments based on the likelihood of the off-balance sheet item becoming an asset. For example, certain loan commitments are converted at 50% and then risk-weighted at 100%. Derivatives are converted to balance sheet equivalents based on notional values, replacement costs and remaining contractual terms. (See Notes 6 and 26 for further discussion of off-balance sheet items.) For certain recourse obligations, direct credit substitutes, residual interests in asset securitization, and other securitized transactions that expose institutions primarily to credit risk, the capital amounts and classiﬁcation under the guidelines are subject to qualitative judgments by the regulators about components, risk weightings and other factors. Actual Ratio Amount For capital adequacy purposes Ratio Amount To be well capitalized under the FDICIA prompt corrective action provisions Ratio Amount As of December 31, 2005: Total capital (to risk-weighted assets) Wells Fargo & Company Wells Fargo Bank, N.A. Tier 1 capital (to risk-weighted assets) Wells Fargo & Company Wells Fargo Bank, N.A. Tier 1 capital (to average assets) (Leverage ratio) Wells Fargo & Company Wells Fargo Bank, N.A. $44.7 34.7 $31.7 25.2 $31.7 25.2 11.64% 11.04 8.26% 8.01 > $30.7 > 25.2 > $15.4 > 12.6 >8.00% >8.00 >4.00% >4.00 >$31.5 >10.00% >$18.9 > 6.00% 6.99% 6.61 >$18.1 > 15.3 >4.00%(1) >4.00 (1) >$19.1 > 5.00% (1) The leverage ratio consists of Tier 1 capital divided by quarterly average total assets, excluding goodwill and certain other items. The minimum leverage ratio guideline is 3% for banking organizations that do not anticipate signiﬁcant growth and that have well-diversiﬁed risk, excellent asset quality, high liquidity, good earnings, effective management and monitoring of market risk and, in general, are considered top-rated, strong banking organizations. 106 Management believes that, as of December 31, 2005, the Company and each of the covered subsidiary banks met all capital adequacy requirements to which they are subject. The most recent notiﬁcation from the OCC categorized each of the covered subsidiary banks as well capitalized, under the FDICIA prompt corrective action provisions applicable to banks. To be categorized as well capitalized, the institution must maintain a total risk-based capital ratio as set forth in the table on the previous page and not be subject to a capital directive order. There are no conditions or events since that notiﬁcation that management believes Note 26: Derivatives Our approach to managing interest rate risk includes the use of derivatives. This helps minimize signiﬁcant, unplanned ﬂuctuations in earnings, fair values of assets and liabilities, and cash ﬂows caused by interest rate volatility. This approach involves modifying the repricing characteristics of certain assets and liabilities so that changes in interest rates do not have a signiﬁcant adverse effect on the net interest margin and cash ﬂows. As a result of interest rate ﬂuctuations, hedged assets and liabilities will gain or lose market value. In a fair value hedging strategy, the effect of this unrealized gain or loss will generally be offset by income or loss on the derivatives linked to the hedged assets and liabilities. In a cash ﬂow hedging strategy, we manage the variability of cash payments due to interest rate ﬂuctuations by the effective use of derivatives linked to hedged assets and liabilities. We use derivatives as part of our interest rate risk management, including interest rate swaps, caps and ﬂoors, futures and forward contracts, and options. We also offer various derivatives, including interest rate, commodity, equity, credit and foreign exchange contracts, to our customers but usually offset our exposure from such contracts by purchasing other ﬁnancial contracts. The customer accom- modations and any offsetting ﬁnancial contracts are treated as free-standing derivatives. Free-standing derivatives also include derivatives we enter into for risk management that do not otherwise qualify for hedge accounting. To a lesser extent, we take positions based on market expectations or to beneﬁt from price differentials between ﬁnancial instruments and markets. By using derivatives, we are exposed to credit risk if counterparties to ﬁnancial instruments do not perform as expected. If a counterparty fails to perform, our credit risk is equal to the fair value gain in a derivative contract. We minimize credit risk through credit approvals, limits and monitoring procedures. Credit risk related to derivatives is considered and, if material, provided for separately. As we generally enter into transactions only with counterparties that carry high quality credit ratings, losses from counterparty nonperformance on derivatives have not been signiﬁcant. Further, we obtain collateral, where appropriate, to reduce risk. To the extent the master netting arrangements meet the requirements of FASB Interpretation No. 39, Offsetting of have changed the risk-based capital category of any of the covered subsidiary banks. As an approved seller/servicer, Wells Fargo Bank, N.A., through its mortgage banking division, is required to maintain minimum levels of shareholders’ equity, as speciﬁed by various agencies, including the United States Department of Housing and Urban Development, Government National Mortgage Association, Federal Home Loan Mortgage Corporation and Federal National Mortgage Association. At December 31, 2005, Wells Fargo Bank, N.A. met these requirements. Amounts Related to Certain Contracts, as amended by FASB Interpretation No. 41, Offsetting of Amounts Related to Certain Repurchase and Reverse Repurchase Agreements, amounts are shown net in the balance sheet. Our derivative activities are monitored by the Corporate Asset/Liability Management Committee. Our Treasury function, which includes asset/liability management, is responsible for various hedging strategies developed through analysis of data from ﬁnancial models and other internal and industry sources. We incorporate the resulting hedging strategies into our overall interest rate risk management and trading strategies. Fair Value Hedges We use derivatives, such as interest rate swaps, swaptions, Treasury futures and options, Eurodollar futures and options, and forward contracts, to manage the risk of changes in the fair value of MSRs and other retained interests. Derivative gains or losses caused by market conditions (volatility) and the spread between spot and forward rates priced into the derivative contracts (the passage of time) are excluded from the evaluation of hedge effectiveness, but are reﬂected in earnings. Net derivative gains and losses related to our mortgage servicing activities are included in “Servicing income, net” in Note 21. We use derivatives, such as Treasury and LIBOR futures and swaptions, to hedge changes in fair value due to changes in interest rates of our commercial real estate mortgages and franchise loans held for sale. The ineffective portion of these fair value hedges is recorded as part of mortgage banking noninterest income in the income statement. We also enter into interest rate swaps, designated as fair value hedges, to convert certain of our ﬁxed-rate long-term debt to ﬂoating- rate debt. In addition, we enter into cross-currency swaps and cross-currency interest rate swaps to hedge our exposure to foreign currency risk and interest rate risk associated with the issuance of non-U.S. dollar denominated debt. For commercial real estate, long-term debt and foreign currency hedges, all parts of each derivative’s gain or loss are included in the assessment of hedge effectiveness. At December 31, 2005, all designated fair value hedges continued to qualify as fair value hedges. 107 Cash Flow Hedges We hedge ﬂoating-rate senior debt against future interest rate increases by using interest rate swaps to convert ﬂoating- rate senior debt to ﬁxed rates and by using interest rate caps and ﬂoors to limit variability of rates. We also use derivatives, such as Treasury futures, forwards and options, Eurodollar futures, and forward contracts, to hedge forecasted sales of mortgage loans. Gains and losses on derivatives that are reclassiﬁed from cumulative other comprehensive income to current period earnings, are included in the line item in which the hedged item’s effect in earnings is recorded. All parts of gain or loss on these derivatives are included in the assessment of hedge effectiveness. As of December 31, 2005, all designated cash ﬂow hedges continued to qualify as cash ﬂow hedges. At December 31, 2005, we expected that $13 million of deferred net losses on derivatives in other comprehensive income will be reclassiﬁed as earnings during the next twelve months, compared with $8 million and $9 million of deferred net losses at December 31, 2004 and 2003, respectively. We are hedging our exposure to the variability of future cash ﬂows for all forecasted transactions for a maximum of one year for hedges converting ﬂoating-rate loans to ﬁxed rates, 10 years for hedges of ﬂoating-rate senior debt and one year for hedges of forecasted sales of mortgage loans. The following table provides derivative gains and losses related to fair value and cash ﬂow hedges resulting from the change in value of the derivatives excluded from the assessment of hedge effectiveness and the change in value of the ineffective portion of the derivatives. (in millions) Gains (losses) from derivatives related to MSRs and other retained interests from change in value of: Derivatives excluded from the assessment of hedge effectiveness Ineffective portion of derivatives Net derivative gains (losses) related to MSRs and other retained interests Losses from ineffective portion of change in the value of other fair value hedges (1) Gains from ineffective portion of change in the value of cash ﬂow hedges (1) Includes commercial real estate, long-term debt and foreign currency. Free-Standing Derivatives We enter into various derivatives primarily to provide derivative products to customers. To a lesser extent, we take positions based on market expectations or to beneﬁt from price differentials between ﬁnancial instruments and markets. These derivatives are not linked to speciﬁc assets and liabilities on the balance sheet or to forecasted transactions in an accounting hedge relationship and, therefore, do not qualify for hedge accounting. We also enter into free-standing derivatives for risk management that do not otherwise qualify for hedge accounting. They are carried at fair value with changes in fair value recorded as part of other noninterest income in the income statement. Interest rate lock commitments for residential mortgage loans that we intend to resell are considered free-standing derivatives. Our interest rate exposure on these derivative loan commitments is economically hedged with Treasury futures, forwards and options, Eurodollar futures, and forward contracts. The commitments and free-standing derivatives are carried at fair value with changes in fair value recorded as a part of mortgage banking noninterest income in the income statement. We record a zero fair value for a derivative loan commitment at inception consistent with EITF 02-3, Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities, 108 2005 $ 338 (384) $ (46) $ (15) $ 23 2004 December 31, 2003 $ 944 (390) $ 554 $ (21) $ 10 $ 908 203 $1,111 $ (22) $ 72 and Securities and Exchange Commission (SEC) Staff Accounting Bulletin No. 105, Application of Accounting Principles to Loan Commitments. Changes subsequent to inception are based on changes in fair value of the underlying loan resulting from the exercise of the commitment and changes in the probability that the loan will fund within the terms of the commitment, which is affected primarily by changes in interest rates and passage of time. The aggregate fair value of derivative loan commitments on the consolidated balance sheet at December 31, 2005 and 2004, was a net liability of $54 million and $38 million, respectively; and is included in the caption “Interest rate contracts – Options written” under Customer Accommodations and Trading in the following table. In 2005, we also used derivatives, such as swaps, swaptions, Treasury futures and options, Eurodollar futures and options, and forward contracts, to economically hedge the risk of changes in the fair value of MSRs and other retained interests, with the resulting gain or loss reﬂected in income. Net derivative gains of $189 million for 2005 from economic hedges related to our mortgage servicing activities are included on the income statement in “Mortgage Banking – Servicing income, net.” The aggregate fair value of these economic hedges was a net asset of $32 million at December 31, 2005, and is included on the balance sheet in “Other assets.” The total notional or contractual amounts, credit risk amount and estimated net fair value for derivatives were: December 31, 2004 Estimated net fair value 2005 Estimated net fair value Notional or contractual amount Credit risk amount (1) Credit risk amount (1) Notional or contractual amount (in millions) ASSET/LIABILITY MANAGEMENT HEDGES Interest rate contracts: Swaps Futures Floors and caps purchased Floors and caps written Options purchased Options written Forwards Equity contracts: Options purchased Options written Forwards Foreign exchange contracts: Swaps Forwards CUSTOMER ACCOMMODATIONS AND TRADING Interest rate contracts: Swaps Futures Floors and caps purchased Floors and caps written Options purchased Options written Forwards Commodity contracts: Swaps Futures Floors and caps purchased Floors and caps written Options purchased Options written Equity contracts: Swaps Futures Options purchased Options written Foreign exchange contracts: Swaps Futures Options purchased Options written Forwards and spots Credit contracts: Swaps $ 36,978 25,485 5,250 5,250 26,508 405 106,146 3 75 15 4,217 1,000 92,462 251,534 7,169 12,653 10,160 41,124 56,644 20,633 555 5,464 6,356 12 52 55 480 1,810 1,601 1,078 53 2,280 2,219 21,516 5,454 $ 409 — 87 — 103 1 126 1 — 2 142 11 1,175 — 33 — 129 41 17 599 — 195 — 7 — 5 — 253 — 35 — 60 — 220 23 $ 26 — 87 (13) 103 (3) 18 1 (3) 2 93 — 133 — 33 (27) 129 (160) (61) (1) — 195 (130) 7 (33) (2) — 253 (263) 1 — 60 (59) 22 (33) $ 27,145 10,314 1,400 — 51,670 — 103,948 25 99 19 — — 74,659 152,943 32,715 34,119 699 26,418 46,167 4,427 230 391 609 35 42 4 730 1,011 935 673 24 2,211 2,187 25,788 5,443 $ 626 — 25 — 49 — 137 1 — 1 — — 1,631 — 170 1 4 45 13 141 — 39 — 17 — — — 189 — 53 — 79 — 489 36 (1) Credit risk amounts reﬂect the replacement cost for those contracts in a gain position in the event of nonperformance by all counterparties. $ 524 — 25 — 49 — 113 1 (18) — — — 28 — 170 (189) 4 (45) (19) (27) — 39 (37) 17 (6) — — 189 (181) 52 — 79 (79) 19 (22) 109 Note 27: Fair Value of Financial Instruments FAS 107, Disclosures about Fair Value of Financial Instruments, requires that we disclose estimated fair values for our ﬁnancial instruments. This disclosure should be read with the ﬁnancial statements and Notes to Financial Statements in this Annual Report. The carrying amounts in the following table are recorded in the Consolidated Balance Sheet under the indicated captions. We base fair values on estimates or calculations using present value techniques when quoted market prices are not available. Because broadly-traded markets do not exist for most of our ﬁnancial instruments, we try to incorporate the effect of current market conditions in the fair value calculations. These valuations are our estimates, and are often calculated based on current pricing policy, the economic and competitive environment, the characteristics of the ﬁnancial instruments and other such factors. These calculations are subjective, involve uncertainties and signiﬁcant judgment and do not include tax ramiﬁcations. Therefore, the results cannot be determined with precision, substantiated by comparison to independent markets and may not be realized in an actual sale or immediate settlement of the instruments. There may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash ﬂows, that could signiﬁcantly affect the results. We have not included certain material items in our disclosure, such as the value of the long-term relationships with our deposit, credit card and trust customers, since these intangibles are not ﬁnancial instruments. For all of these reasons, the total of the fair value calculations presented do not represent, and should not be construed to represent, the underlying value of the Company. Financial Assets SHORT-TERM FINANCIAL ASSETS Short-term ﬁnancial assets include cash and due from banks, federal funds sold and securities purchased under resale agreements and due from customers on acceptances. The carrying amount is a reasonable estimate of fair value because of the relatively short time between the origination of the instrument and its expected realization. TRADING ASSETS Trading assets are carried at fair value. SECURITIES AVAILABLE FOR SALE Securities available for sale are carried at fair value. For further information, see Note 5. MORTGAGES HELD FOR SALE The fair value of mortgages held for sale is based on quoted market prices or on what secondary markets are currently offering for portfolios with similar characteristics. 110 LOANS HELD FOR SALE The fair value of loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics. LOANS The fair valuation calculation differentiates loans based on their ﬁnancial characteristics, such as product classiﬁcation, loan category, pricing features and remaining maturity. Prepayment estimates are evaluated by product and loan rate. The fair value of commercial loans, other real estate mortgage loans and real estate construction loans is calculated by discounting contractual cash ﬂows using discount rates that reﬂect our current pricing for loans with similar characteristics and remaining maturity. For real estate 1-4 family ﬁrst and junior lien mortgages, fair value is calculated by discounting contractual cash ﬂows, adjusted for prepayment estimates, using discount rates based on current industry pricing for loans of similar size, type, remaining maturity and repricing characteristics. For consumer ﬁnance and credit card loans, the portfolio’s yield is equal to our current pricing and, therefore, the fair value is equal to book value. For other consumer loans, the fair value is calculated by discounting the contractual cash ﬂows, adjusted for prepayment estimates, based on the current rates we offer for loans with similar characteristics. Loan commitments, standby letters of credit and commercial and similar letters of credit not included in the following table had contractual values of $191.4 billion, $10.9 billion and $761 million, respectively, at December 31, 2005, and $164.0 billion, $9.4 billion and $731 million, respectively, at December 31, 2004. These instruments generate ongoing fees at our current pricing levels. Of the commitments at December 31, 2005, 40% mature within one year. Deferred fees on commitments and standby letters of credit totaled $47 million and $46 million at December 31, 2005 and 2004, respectively. Carrying cost estimates fair value for these fees. NONMARKETABLE EQUITY INVESTMENTS There are generally restrictions on the sale and/or liquidation of our nonmarketable equity investments, including federal bank stock. Federal bank stock carrying value approximates fair value. We use all facts and circumstances available to estimate the fair value of our cost method investments. We typically consider our access to and need for capital (including recent or projected ﬁnancing activity), qualitative assessments of the viability of the investee, and prospects for its future. Financial Liabilities DEPOSIT LIABILITIES FAS 107 states that the fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, interest-bearing checking and market rate and other savings, is equal to the amount payable on demand at the measurement date. The amount included for these deposits in the following table is their carrying value at December 31, 2005 and 2004. The fair value of other time deposits is calculated based on the discounted value of contractual cash ﬂows. The discount rate is estimated using the rates currently offered for like wholesale deposits with similar remaining maturities. SHORT-TERM FINANCIAL LIABILITIES Short-term ﬁnancial liabilities include federal funds pur- chased and securities sold under repurchase agreements, commercial paper and other short-term borrowings. The carrying amount is a reasonable estimate of fair value because of the relatively short time between the origination of the instrument and its expected realization. LONG-TERM DEBT The discounted cash ﬂow method is used to estimate the fair value of our ﬁxed-rate long-term debt. Contractual cash ﬂows are discounted using rates currently offered for new notes with similar remaining maturities. Derivatives The fair values of derivatives are reported in Note 26. Limitations We make these fair value disclosures to comply with the requirements of FAS 107. The calculations represent man- agement’s best estimates; however, due to the lack of broad markets and the signiﬁcant items excluded from this disclosure, the calculations do not represent the underlying value of the Company. The information presented is based on fair value calculations and market quotes as of December 31, 2005 and 2004. These amounts have not been updated since year end; therefore, the valuations may have changed signiﬁcantly since that point in time. As discussed above, some of our asset and liability ﬁnancial instruments are short-term, and therefore, the carrying amounts in the Consolidated Balance Sheet approximate fair value. Other signiﬁcant assets and liabilities, which are not consid- ered ﬁnancial assets or liabilities and for which fair values have not been estimated, include mortgage servicing rights, premises and equipment, goodwill and other intangibles, deferred taxes and other liabilities. This table is a summary of ﬁnancial instruments, as deﬁned by FAS 107, excluding short-term ﬁnancial assets and liabilities, for which carrying amounts approximate fair value, and trading assets, securities available for sale and derivatives, which are carried at fair value. (in millions) FINANCIAL ASSETS Mortgages held for sale Loans held for sale Loans, net Nonmarketable equity investments FINANCIAL LIABILITIES Deposits Long-term debt (1) December 31, 2004 2005 Estimated Estimated fair value fair value Carrying amount Carrying amount $ 40,534 612 306,966 5,090 $ 40,666 629 307,721 5,533 $ 29,723 8,739 283,824 5,229 $ 29,888 8,972 285,488 5,494 314,450 79,654 314,301 78,868 274,858 73,560 274,900 74,085 (1) The carrying amount and fair value exclude obligations under capital leases of $14 million and $20 million at December 31, 2005 and 2004, respectively. 111 Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders Wells Fargo & Company: We have audited the accompanying consolidated balance sheet of Wells Fargo & Company and Subsidiaries (“the Company”) as of December 31, 2005 and 2004, and the related consolidated statements of income, changes in stockholders’ equity and comprehensive income, and cash ﬂows for each of the years in the three-year period ended December 31, 2005. These consolidated ﬁnancial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated ﬁnancial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the ﬁnancial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the ﬁnancial statements. An audit also includes assessing the accounting principles used and signiﬁcant estimates made by management, as well as evaluating the overall ﬁnancial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated ﬁnancial statements referred to above present fairly, in all material respects, the ﬁnancial position of the Company as of December 31, 2005 and 2004, and the results of their operations and their cash ﬂows for each of the years in the three-year period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over ﬁnancial reporting as of December 31, 2005, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 21, 2006, expressed an unqualiﬁed opinion on management’s assessment of, and the effective operation of, internal control over ﬁnancial reporting. San Francisco, California February 21, 2006 112 Quarterly Financial Data Condensed Consolidated Statement of Income — Quarterly (Unaudited) (in millions, except per share amounts) INTEREST INCOME INTEREST EXPENSE NET INTEREST INCOME 2005 Quarter ended Mar. 31 Sept. 30 June 30 Dec. 31 2004 Quarter ended Mar. 31 Sept. 30 June 30 Dec. 31 $ 7,244 $ 6,645 1,969 4,676 2,405 4,839 $ 6,200 1,664 4,536 $ 5,873 1,420 4,453 $ 5,635 1,179 4,456 $ 5,405 987 4,418 Provision for credit losses Net interest income after provision for credit losses 703 4,136 641 4,035 454 4,082 NONINTEREST INCOME Service charges on deposit accounts Trust and investment fees Card fees Other fees Mortgage banking Operating leases Insurance Net gains (losses) on debt securities available for sale Net gains from equity investments Other Total noninterest income NONINTEREST EXPENSE Salaries Incentive compensation Employee beneﬁts Equipment Net occupancy Operating leases Other Total noninterest expense INCOME BEFORE INCOME TAX EXPENSE Income tax expense 655 623 394 478 628 200 272 (124) 93 434 3,653 1,613 663 428 328 344 161 1,346 4,883 2,906 976 654 614 377 520 743 202 248 (31) 146 354 3,827 1,571 676 467 306 354 159 1,356 4,889 2,973 998 625 597 361 478 237 202 358 39 201 231 3,329 1,551 562 432 263 310 157 1,279 4,554 2,857 947 585 3,868 578 602 326 453 814 208 337 (4) 71 251 3,636 1,480 465 547 370 404 158 1,268 4,692 2,812 956 465 3,991 594 543 321 479 790 211 265 3 170 336 3,712 1,438 526 451 410 301 164 1,681 4,971 2,732 947 408 4,010 618 508 319 452 262 207 264 10 48 212 2,900 1,383 449 390 254 309 158 1,277 4,220 2,690 942 $ 5,069 843 4,226 440 3,786 $ 4,858 808 4,050 404 3,646 611 530 308 437 493 209 347 (61) 81 245 3,200 1,295 441 391 271 304 156 1,495 4,353 2,633 919 594 535 282 411 315 209 317 33 95 306 3,097 1,277 391 492 301 294 155 1,119 4,029 2,714 947 NET INCOME $ 1,930 $ 1,975 $ 1,910 $ 1,856 $ 1,785 $ 1,748 $ 1,714 $ 1,767 EARNINGS PER COMMON SHARE DILUTED EARNINGS PER COMMON SHARE DIVIDENDS DECLARED PER COMMON SHARE $ $ $ 1.15 $ 1.17 $ 1.14 1.14 $ 1.16 $ 1.12 $ $ 1.09 1.08 .52 $ .52 $ .48 $ .48 $ $ $ 1.06 1.04 .48 $ $ $ 1.03 1.02 .48 $ $ $ 1.02 $ 1.04 1.00 $ 1.03 .45 $ .45 Average common shares outstanding 1,675.4 1,686.8 1,687.7 1,695.4 1,692.7 1,688.9 1,688.1 1,699.3 Diluted average common shares outstanding 1,693.9 1,705.3 1,707.2 1,715.7 1,715.0 1,708.7 1,708.3 1,721.2 Market price per common share (1) High Low Quarter end $ 64.70 $ 62.87 58.00 58.57 57.62 62.83 $ 62.22 57.77 61.58 $ 62.75 58.15 59.80 $ 64.04 57.55 62.15 $ 59.86 56.12 59.63 $ 59.72 54.32 57.23 $ 58.98 55.97 56.67 (1) Based on daily prices reported on the New York Stock Exchange Composite Transaction Reporting System. 113 Average Balances, Yields and Rates Paid (Taxable-Equivalent Basis) — Quarterly (1)(2) (Unaudited) (in millions) EARNING ASSETS Federal funds sold, securities purchased under resale agreements and other short-term investments Trading assets Debt securities available for sale (3): Securities of U.S. Treasury and federal agencies Securities of U.S. states and political subdivisions Mortgage-backed securities: Federal agencies Private collateralized mortgage obligations Total mortgage-backed securities Other debt securities (4) Total debt securities available for sale (4) Mortgages held for sale (3) Loans held for sale (3) Loans: Commercial and commercial real estate: Commercial Other real estate mortgage Real estate construction Lease ﬁnancing Total commercial and commercial real estate Consumer: Real estate 1-4 family ﬁrst mortgage Real estate 1-4 family junior lien mortgage Credit card Other revolving credit and installment Total consumer Foreign Other Total loans (5) Total earning assets FUNDING SOURCES Deposits: Interest-bearing checking Market rate and other savings Savings certiﬁcates Other time deposits Deposits in foreign ofﬁces Total interest-bearing deposits Short-term borrowings Long-term debt Total interest-bearing liabilities Portion of noninterest-bearing funding sources Total funding sources Net interest margin and net interest income on a taxable-equivalent basis (6) NONINTEREST-EARNING ASSETS Cash and due from banks Goodwill Other Total noninterest-earning assets NONINTEREST-BEARING FUNDING SOURCES Deposits Other liabilities Stockholders’ equity Noninterest-bearing funding sources used to fund earning assets Net noninterest-bearing funding sources TOTAL ASSETS Average balance 2005 Interest Yields/ income/ rates expense Quarter ended December 31, 2004 Interest Yields/ income/ rates expense Average balance $ 5,158 5,061 3.64% 3.82 $ 47 48 $ 4,967 5,040 2.01% 2.73 $ 26 34 1,051 3,256 23,545 8,060 31,605 4,843 40,755 42,036 603 61,297 28,425 13,040 5,347 108,109 76,233 58,157 11,326 46,593 192,309 5,278 305,696 1,415 $400,724 $ 3,797 132,042 26,610 33,321 14,347 210,117 25,395 79,169 314,681 86,043 $400,724 $ 13,508 10,780 43,469 $ 67,757 $ 90,937 23,049 39,814 (86,043) $ 67,757 $468,481 3.90 8.22 5.94 5.71 5.88 6.79 6.12 5.97 6.41 7.35 6.84 7.26 5.77 7.13 6.75 7.28 12.81 9.13 7.84 13.08 7.68 4.49 7.23 1.79 1.86 3.26 4.07 3.71 2.51 3.79 4.19 3.04 — 2.39 10 64 347 114 461 82 617 628 10 1,135 489 239 77 1,940 1,291 1,067 363 1,071 3,792 174 5,906 16 7,272 17 619 219 341 135 1,331 242 832 2,405 — 2,405 1,101 3,624 21,916 3,787 25,703 3,246 33,674 32,373 8,536 51,896 29,412 9,246 5,109 95,663 86,389 50,909 9,706 34,475 181,479 4,025 281,167 1,698 $367,455 $ 3,244 125,350 18,697 30,460 10,026 187,777 26,315 70,646 284,738 82,717 $367,455 3.72 8.31 6.08 5.35 5.97 7.91 6.32 5.48 4.05 5.93 5.67 5.80 5.84 5.84 5.70 5.54 11.57 8.99 6.59 14.00 6.44 4.19 6.16 .68 .83 2.32 1.98 1.95 1.22 1.90 2.70 1.65 — 1.28 10 71 321 49 370 59 510 443 87 774 419 135 75 1,403 1,233 709 281 779 3,002 141 4,546 17 5,663 5 262 108 152 49 576 126 477 1,179 — 1,179 4.84% $4,867 4.88% $4,484 $ 13,366 10,436 34,002 $ 57,804 $ 82,958 20,336 37,227 (82,717) $ 57,804 $425,259 (1) Our average prime rate was 6.97% and 4.94% for the quarters ended December 31, 2005 and 2004, respectively. The average three-month London Interbank Offered Rate (LIBOR) was 4.34% and 2.30% for the same quarters, respectively. (2) Interest rates and amounts include the effects of hedge and risk management activities associated with the respective asset and liability categories. (3) Yields are based on amortized cost balances computed on a settlement date basis. (4) Includes certain preferred securities. (5) Nonaccrual loans and related income are included in their respective loan categories. (6) Includes taxable-equivalent adjustments primarily related to tax-exempt income on certain loans and securities. The federal statutory tax rate was 35% for both quarters presented. 114 114 Glossary Collateralized debt obligations: Securitized corporate debt. Core deposits: Deposits acquired in a bank’s natural market area, counted as a stable source of funds for lending. These deposits generally have a predictable cost and customer loyalty. Core deposit intangibles: The present value of the difference in cost of funding provided by core deposit balances compared with alternative funding with similar terms assigned to acquired core deposit balances by a buyer. Cost method of accounting: Investment in the subsidiary is carried at cost, and the parent company accounts for the subsidiary’s operations only to the extent that the subsidiary declares dividends. Generally used if investment ownership is less than 20%. Derivatives: Financial contracts whose value is derived from publicly traded securities, interest rates, currency exchange rates or market indices. Derivatives cover a wide assortment of ﬁnancial contracts, including forward contracts, futures, options and swaps. Diluted earnings per share: Net income divided by the average number of common shares outstanding during the year, plus the effect of common stock equivalents (for example, stock options, restricted share rights and convertible debentures) that are dilutive. Earnings per share: Net income divided by the average number of common shares outstanding during the year. Effectiveness/ineffectiveness (of derivatives): Effectiveness is the gain or loss on a hedging instrument that exactly offsets the loss or gain on the hedged item. Any difference would be the effect of hedge ineffectiveness, which is recognized currently in earnings. Equity method of accounting: Investment in the subsidiary is originally recorded at cost, and the value of the investment is increased or decreased based on the investor’s proportional share of the change in the subsidiary’s net worth. Generally used if investment ownership is 20% or more but less than 50%. Federal Reserve Board (FRB): The Board of Governors of the Federal Reserve System, charged with supervising and regulating bank holding companies, including ﬁnancial holding companies. Futures and forward contracts: Contracts in which the buyer agrees to purchase and the seller agrees to deliver a speciﬁc ﬁnancial instrument at a predetermined price or yield. May be settled either in cash or by delivery of the underlying ﬁnancial instrument. GAAP (Generally accepted accounting principles): Accounting rules and conventions deﬁning acceptable practices in recording transactions and preparing ﬁnancial statements. U.S. GAAP is primarily determined by the Financial Accounting Standards Board (FASB). Hedge: Financial technique to offset the risk of loss from price ﬂuctuations in the market by offsetting the risk in another transaction. The risk in one position counterbalances the risk in another transaction. Interest rate ﬂoors and caps: Interest rate protection instruments where the seller pays the buyer an interest differential, which represents the difference between a short-term rate (e.g., three- month LIBOR) and an agreed-upon rate (the strike rate) applied to a notional principal amount. Interest rate swap contracts: Primarily an asset/liability management strategy to reduce interest rate risk. Interest rate swap contracts are exchanges of interest rate payments, such as ﬁxed-rate payments for ﬂoating-rate payments, based on notional principal amounts. Mortgage servicing rights: The rights to service mortgage loans for others, which are acquired through purchases or kept after sales or securitizations of originated loans. Net interest margin: The average yield on earning assets minus the average interest rate paid for deposits and debt. Notional amount: A number of currency units, shares, or other units speciﬁed in a derivative contract. Ofﬁce of the Comptroller of the Currency (OCC): Part of the U.S. Treasury department and the primary regulator for banks with national charters. Options: Contracts that grant the purchaser, for a premium payment, the right, but not the obligation, to either purchase or sell the associated ﬁnancial instrument at a set price during a period or at a speciﬁed date in the future. Other-than-temporary impairment: A write-down of certain assets recorded when a decline in the fair market value below the carrying value of the asset is considered not to be temporary. Applies to goodwill, mortgage servicing rights, other intangible assets, securities available for sale and nonmarketable equity securities. (See Note 1 – Summary of Signiﬁcant Accounting Policies for impairment policies for speciﬁc categories of assets.) Qualifying special-purpose entities (QSPE): A trust or other legal vehicle that meets certain conditions, including (1) that it is distinct from the transferor, (2) activities are limited, and (3) the types of assets it may hold and conditions under which it may dispose of noncash assets are limited. A QSPE is not consolidated on the balance sheet. Securitize/securitization: The process and the result of pooling ﬁnancial assets together and issuing liability and equity obligations backed by the resulting pool of assets to convert those assets into marketable securities. Special-purpose entities (SPE): A legal entity, sometimes a trust or a limited partnership, created solely for the purpose of holding assets. Taxable-equivalent basis: Basis of presentation of net interest income and the net interest margin adjusted to consistently reﬂect income from taxable and tax-exempt loans and securities based on a 35% marginal tax rate. The yield that a tax-free investment would provide to an investor if the tax-free yield was “grossed up” by the amount of taxes not paid. Underlying: A speciﬁed interest rate, security price, commodity price, foreign exchange rate, index of prices or rates or other variable. An underlying may be the price or rate of an asset or liability, but is not the asset or liability itself. Value at risk: The amount or percentage of value that is at risk of being lost from a change in prevailing interest rates. Variable interest entity (VIE): An entity in which the equity investors (1) do not have a controlling ﬁnancial interest, or (2) do not have sufﬁcient equity at risk for the entity to ﬁnance its activities without subordinated ﬁnancial support from other parties. Yield curve (shape of the yield curve, ﬂat yield curve): A graph showing the relationship between the yields on bonds of the same credit quality with different maturities. For example, a “normal”, or “positive”, yield curve exists when long-term bonds have higher yields than short-term bonds. A “ﬂat” yield curve exists when yields are the same for short-term and long-term bonds. A “steep” yield curve exists when yields on long-term bonds are signiﬁcantly higher than on short-term bonds. 115 Wells Fargo & Company Highest Market Caps, Year-End 2005, among Fortune 100 Market Cap Fortune Rank* (Revenue) 1. General Electric (GE) 2. Exxon Mobil (XOM) 3. Microsoft (MSFT) 4. Citigroup (C) 5. Wal-Mart Stores (WMT) 6. Bank of America (BAC) 7. 8. AIG (AIG) 9. Pﬁzer (PFE) Intel (INTC) Johnson & Johnson (JNJ) 10. $372 billion 363 287 246 190 187 185 181 181 158 5 2 41 8 1 18 30 9 24 50 11. Altria Group (MO) 12. Procter & Gamble (PG) 13. JP Morgan Chase (JPM) 14. Berkshire Hathaway 15. ChevronTexaco (CVX) 16. 17. Cisco Systems (CSCO) 18. Wells Fargo (WFC) 19. PepsiCo (PEP) 20. Coca-Cola (KO) IBM (IBM) 157 140 139 138 131 130 113 105 99 98 17 26 20 12 6 10 91 52 61 92 *4/05 Stock Listing Wells Fargo & Company is listed and trades on the New York Stock Exchange and the Chicago Stock Exchange in the United States. Our trading symbol is WFC. Common Stock 1,677,583,032 common shares outstanding (12/31/05) Stock Purchase and Dividend Reinvestment You can buy Wells Fargo stock directly from Wells Fargo, even if you’re not a Wells Fargo stockholder, through optional cash payments or automatic monthly deductions from a bank account.You can also have your dividends reinvested automatically. It’s a convenient, economical way to increase your Wells Fargo investment. Call 1-877-840-0492 for an enrollment kit including a plan prospectus. Form 10-K We will send the Wells Fargo’s 2005 Annual Report on Form 10-K (including the ﬁnancial statements ﬁled with the Securities and Exchange Commission) without charge to any stockholder who asks for a copy in writing. Stockholders also can ask for copies of any exhibit to the Form 10-K. We will charge a fee to cover expenses to prepare and send any exhibits. Please send requests to: Corporate Secretary, Wells Fargo & Company, Wells Fargo Center, MAC N9305-173, Sixth and Marquette, Minneapolis, MN 55479. SEC Filings Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, are available free of charge on our website (www.wellsfargo.com), as soon as reasonably practicable after they are electronically ﬁled with or furnished to the SEC.Those reports and amendments are also available free of charge on the SEC’s website at www.sec.gov. Independent Registered Public Accounting Firm KPMG LLP San Francisco, CA 415-963-5100 Contacts Investor Relations 1-888-662-7865 investorrelations@wellsfargo.com Stockholder Communications Shareholder Services and Transfer Agent Wells Fargo Shareowner Services P.O. Box 64854 Saint Paul, MN 55164-0854 1-877-840-0492 www.wellsfargo.com/com/shareowner_services Corporate Information Annual Stockholders’ Meeting 1:30 p.m., Tuesday, April 25, 2006 The Stanford Court Hotel 905 California Street San Francisco, CA Proxy statement and form of proxy will be mailed to stockholders beginning on or about March 17, 2006. Certiﬁcations Our chief executive ofﬁcer certiﬁed to the New York Stock Exchange (NYSE) that, as of May 23, 2005, he was not aware of any violation by the Company of the NYSE’s corporate governance listing standards. The certiﬁcations of our chief executive ofﬁcer and chief ﬁnancial ofﬁcer required under Section 302 of the Sarbanes-Oxley Act of 2002 were ﬁled as Exhibits 31(a) and 31(b), respectively, to our 2005 Form 10-K. FORWARD-LOOKING STATEMENTS In this report we may make forward-looking statements about our company’s ﬁnancial condition, results of operations, plans, objectives and future performance and business. We make forward-looking statements when we use words such as “believe,” “expect,” “anticipate,” “estimate,” “may,” “can,” “will” or similar expressions. Forward-looking statements involve risks and uncertainties. They are based on current expectations. Several factors could cause actual results to differ signiﬁcantly from expectations including • our ability to grow revenue by selling more products to our customers • the effect of an economic slowdown on the demand for our products and services • the effect of a fall in stock market prices on fee income from our brokerage and asset management businesses • the effect of changes in interest rates on our net interest margin and our mortgage originations and mortgage servicing rights • the adequacy of our loan loss allowance • changes in the value of our venture capital investments • changes in our accounting policies or in accounting standards • mergers and acquisitions • federal and state regulations • reputational damage from negative publicity • the loss of checking and saving account deposits to other investments such as the stock market • ﬁscal and monetary policies of the Federal Reserve Board. For more information about factors that could cause actual results to differ from expectations, refer to the Financial Review and the Financial Statements and related Notes in this report and to the “Risk Factors” and “Regulation and Supervision” sections of our 2005 Annual Report on Form 10-K ﬁled with the Securities and Exchange Commission and available on the SEC’s website at www.sec.gov. © 2006 Wells Fargo & Company. All rights reserved. 116 Which Measures Really Matter? 2005 Update In our past two annual reports, we said to you, our owners, that we measure success differently than our competitors—to reﬂect more accurately how ﬁnancial services companies, like ours, create value for customers and stockholders. Here’s an update on the progress we’re making in the areas we believe are the best long-term indicators for future success in the ﬁnancial services industry. Financial Performance* . 9 2 3 . 1 0 3 . 4 8 2 . 2 5 2 . 0 1 2 $ 0 5 4 . 9 0 4 . 5 6 3 . 2 3 3 . . 7 9 1 $ . 7 8 1 . 4 9 1 . 6 9 1 . 6 9 1 % 7 2 1 . 5 0 1 5 0 1 0 0 1 9 7 4 7 $ 03 02 01 04 Revenue (billions) 20-year compound annual growth rate: 12% 05 03 02 04 01 Earnings Per Share diluted** 20-year compound annual growth rate: 14% 05 05 04 02 01 03 Return on Equity (ROE) ROE: cents earned for every dollar stockholders invest in the company * before effect of change in accounting principles, 2001 includes venture capital impairment ** includes all common stock equivalents (”in the money stock” options, warrants and rights, convertible bonds and convertible preferred stock) Sales 3 4 . 0 4 . 7 4 . . 8 4 9 4 . 2 4 . 8 3 . 6 3 4 4 . . 8 4 . 9 4 . 6 4 . 7 3 5 . . 0 5 5 . . 1 1 9 3 6 2 . . 7 3 2 % 2 3 2 . 02 04 01 03 05 Market Capitalization (billions) . 1 3 3 . 4 5 8 . 9 5 8 . 7 8 8 . 5 0 9 % 3 3 8 . 05 04 03 02 01 Product Solutions (Sales) Per Banker* Per Day * platform full-time equivalent (FTE) team member 04 02 01 03 Products Per Banking Household 05 05 03 04 02 01 Commercial/Corporate Products Per Banking Customer 04 02 03 01 Retail Banking Households with Credit Cards 05 04 03 02 01 Retail Checking Households with Debit Cards 05 Managing Risk The higher a company’s credit rating (based on its ability to meet debt obli- gations) the less interest it has to pay to borrow money.Wells Fargo Bank: only U.S. bank rated “Aaa.” Moody’s Number of S&P companies with higher rating Wells Fargo Bank, N.A. Issuer Long-term deposits Financial Strength Wells Fargo & Company Subordinated Debt Issuer Senior Debt Aaa Aaa A Aa2 Aa1 Aa1 None None None One Six Six % 8 0 1 . 8 8 0 . 6 6 0 . 5 5 0 . 9 4 0 . 04 03 02 01 Nonperforming Assets (NPAs)/Total Loans 05 Earning More Business 4 1 3 5 7 2 8 4 2 7 1 2 7 8 1 $ 03 04 05 02 01 Deposits (billions) 0 7 4 3 3 3 6 6 3 8 9 2 2 0 2 $ 9 8 9 5 0 8 0 1 7 1 8 5 2 6 4 $ 0 7 2 7 9 4 4 3 5 2 $ 0 8 8 1 9 7 4 5 8 6 7 5 $ 04 02 01 03 Mortgage Originations (billions) 05 04 02 03 01 05 Mortgage Servicing Portfolio (billions) 04 05 02 03 01 National Home Equity Group Loans (billions) 03 04 05 02 Assets Managed, Administered (billions) includes brokerage Retaining Customers, Team Members ) . t s e ( % 4 0 1 . 9 8 . 0 8 . 5 7 . 5 7 . 1 : 8 5 . 1 : . 1 4 1 : 5 2 . 1 : 7 1. * * % 4 3 8 2 9 2 5 2 0 3 Online 8 1 8 8 2 5 2 2 2 6 6 6 1 3 5 5 1 4 7 9 2 5 8 1 02 04 01 05 03 Retaining Customers (annual percent of high-value* checking account customers who leave us) * top 20 percent of banking customers based on balances 05 04 National average 03 Team Member Engagement Ratio of engaged to actively disengaged Gallup survey of Wells Fargo Regional Banking team members 02 04 03 01 Retaining Team Members (annual percent of team members who leave us) 05 ** excludes Wells Fargo Financial (consumer finance) 05 02 03 01 04 Active Online Middle-Market/ Large Corporate Customers (thousands) 05 02 04 03 01 Active Online Small Business Customers (thousands) OUR VISION: Satisfy all our customers’ financial needs and help them succeed financially. NUESTRA VISION: Deseamos satisfacer todas las necesidades financieras de nuestros clientes y ayudarlos a tener éxito en el área financiera. NOTRE VISION: Satisfaire tous les besoins ﬁnanciers de nos clients et les aider à atteindre le succès ﬁnancier. Wells Fargo & Company 420 Montgomery Street San Francisco, California 94104 1-866-878- 5865 wellsfargo.com America’s “Most admired” Large Bank Fortune

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