Wells Fargo - 10-Q quarterly report FY

Wells Fargo & Company is a $1.3 trillion diversified financial services company providing banking, insurance, investments, mortgage banking, investment banking, retail banking, brokerage and consumer finance through banking stores, the internet and other distribution channels to consumers, businesses and institutions in all 50 states, the District of Columbia and in other countries. We ranked fourth in assets and second in market value of our common stock among our peers at March 31, 2009. When we refer to “Wells Fargo,” “the Company,” “we,” “our” or “us” in this Report, we mean Wells Fargo & Company and Subsidiaries (consolidated). When we refer to the “Parent,” we mean Wells Fargo & Company. When we refer to “legacy Wells Fargo,” we mean Wells Fargo excluding Wachovia Corporation (Wachovia).

Wells Fargo net income was a record $3.05 billion in first quarter 2009, with net income applicable to common stock of $2.38 billion. Earnings per common share were $0.56, after merger-related and restructuring expense of $206 million ($0.03 per common share) and a $1.3 billion credit reserve build ($0.19 per common share).

On December 31, 2008, Wells Fargo acquired Wachovia. Because the acquisition was completed at the end of 2008, Wachovia’s results are included in the income statement, average balances and related metrics beginning in 2009. Wachovia’s assets and liabilities are included, at fair value, in the consolidated balance sheet beginning on December 31, 2008, but not in averages.

On January 1, 2009, we adopted Statement of Financial Accounting Standards (FAS) No. 160,Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51, on a retrospective basis for disclosure and, accordingly, prior period information reflects the adoption. FAS 160 requires that noncontrolling interests be reported as a component of total equity. In addition, FAS 160 requires that the consolidated income statement disclose amounts attributable to both Wells Fargo interests and the noncontrolling interests.

Our vision is to satisfy all our customers’ financial needs, help them succeed financially, be recognized as the premier financial services company in our markets and be one of America’s great companies. Our primary strategy to achieve this vision is to increase the number of products our customers buy from us and to give them all of the financial products that fulfill their needs. Our cross-sell strategy and diversified business model facilitate growth in both strong and weak economic cycles, as we can grow by expanding the number of products our current

customers have with us. We continued to earn more of our customers’ business in 2009 in both our retail and commercial banking businesses.

Despite the continuing turmoil in the credit markets, we continued to lend to credit-worthy customers. We extended significant credit to U.S. taxpayers in first quarter 2009, $190 billion in mortgage applications and $101 billion in mortgage originations – we helped over 450,000 homeowners purchase a home or refinance. We have extended more than $225 billion in credit to U.S. taxpayers since last October. The fundamentals of our time-tested business model are as sound as ever. In first quarter 2009, our average core deposits were $754 billion. Our cross-sell at legacy Wells Fargo set records for the tenth consecutive year – our average retail banking household now has 5.81 products, almost one of every four has eight or more products, 6.4 products for Wholesale Banking customers, and our average middle-market commercial banking customer has almost eight products. Business banking cross-sell reached 3.66 products at legacy Wells Fargo. Our goal is eight products per customer, which is currently half of our estimate of potential demand.

We have stated in the past that to consistently grow over the long term, successful companies must invest in their core businesses and maintain strong balance sheets. In first quarter 2009, we opened 14 banking stores throughout the combined Company for a retail network total of 6,638 stores. Conversion of Wachovia stores to the Wells Fargo platform is scheduled to begin later this year.

We believe it is important to maintain a well-controlled environment as we continue to grow our businesses and integrate the Wachovia businesses. We manage our credit risk by setting what we believe are sound credit policies for underwriting new business, while monitoring and reviewing the performance of our loan portfolio. We manage the interest rate and market risks inherent in our asset and liability balances within prudent ranges, while ensuring adequate liquidity and funding. We maintain strong capital levels to provide for future growth.

On December 31, 2008, Wells Fargo acquired Wachovia, one of the nation’s largest diversified financial services companies. Wachovia’s assets and liabilities were included in the December 31, 2008, consolidated balance sheet at their respective acquisition date fair values. Because the acquisition was completed on December 31, 2008, Wachovia’s results of operations were not included in our 2008 income statement, and Wachovia’s assets and liabilities did not contribute to the consolidated averages. Beginning in 2009, our consolidated results and our consolidated average balances include Wachovia.

Because the transaction closed on the last day of the annual reporting period, certain fair value purchase accounting adjustments were based on preliminary data as of an interim period with estimates through year end. Accordingly, we are re-validating and, where necessary, refining our December 31, 2008, fair value estimates and other purchase accounting adjustments. The impact of these refinements was recorded as an adjustment to goodwill in first quarter 2009. Based on the purchase price of $23.1 billion and the $13.1 billion fair value of net assets acquired, inclusive of refinements identified in first quarter 2009, the transaction resulted in goodwill of $9.9 billion.

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

Loans subject to SOP 03-3 are written down to an amount estimated to be collectible. Accordingly, such loans are not classified as nonaccrual even though they may be contractually past due because we expect to fully collect the new carrying values of such loans (that is, the new cost basis arising out of our purchase accounting). Loans subject to SOP 03-3 are also excluded from the disclosure of loans 90 days or more past due and still accruing interest even though certain of them are 90 days or more contractually past due.

As a result of the application of SOP 03-3 to certain of Wachovia’s loans, certain ratios of the combined Company cannot be used to compare a portfolio that includes acquired credit-impaired loans accounted for under SOP 03-3 against ones that do not, for example, in comparing peer companies, and cannot be used to compare ratios across periods such as periods that include the Wachovia acquisition against prior periods that do not. The ratios particularly affected by the accounting under SOP 03-3 include the allowance for loan losses and allowance for credit losses as percentages of loans, of nonaccrual loans and of nonperforming assets; nonaccrual loans and nonperforming assets as a percentage of total loans; and net charge-offs as a percentage of average loans.

For further detail on the merger see “Loan Portfolio” in this section and Note 2 (Business Combinations) to Financial Statements in this Report.

Wells Fargo net income in first quarter 2009 was $3.05 billion ($0.56 per share), compared with $2.00 billion ($0.60 per share) in first quarter 2008. Wells Fargo return on average total assets (ROA) was 0.96% and return on average common stockholders’ equity (ROE) was 14.49% in first quarter 2009, compared with 1.40% and 16.86%, respectively, in first quarter 2008. Revenue, the sum of net interest income and noninterest income, of $21.02 billion in first quarter 2009 included another quarter of record, double-digit revenue growth at legacy Wells Fargo, up 16% year over year, as well as a strong contribution from Wachovia, which accounted for 41% of the Company’s combined revenue. Our results also reflected growth at legacy Wells Fargo in both net interest income and fee income resulting from our diversified business model. The breadth and depth of our business model resulted in strong and balanced growth in loans, deposits and fee-based products.

Our balance sheet is well positioned given the current economic environment. Our allowance for credit losses was $22.8 billion at March 31, 2009, compared with $21.7 billion at December 31, 2008. Our allowance was adequate to cover expected consumer losses for at least the next 12 months and to provide approximately 24 months of anticipated loss coverage for the commercial and commercial real estate portfolios. We reduced risk in our balance sheet

through write-downs taken at December 31, 2008, on Wachovia’s higher-risk loan and securities portfolios. We recorded $516 million of other-than-temporary impairment on securities in first quarter 2009. Our ratio of capitalized mortgage servicing rights (MSRs) to owned servicing declined to 74 basis points, the lowest ratio since 2003. Since year-end 2008, our higher risk portfolios (home equity loans originated through third party channels, Pick-a-Pay and indirect auto at legacy Wells Fargo) were reduced by $4.5 billion and trading assets by $8.4 billion.

Our financial results included the following:

Net interest income on a taxable-equivalent basis was $11.55 billion in first quarter 2009, with approximately 40% contributed by Wachovia, up from $5.81 billion in first quarter 2008, reflecting a strong combined net interest margin on average earnings assets of $1.11 trillion. At 4.16% in first quarter 2009, our net interest margin remained strong and the highest among our large bank peers, due in part to continued growth in core deposits and deposit pricing discipline.

Noninterest income reached $9.6 billion in first quarter 2009, up from $4.8 billion a year ago, driven by continued success in satisfying customers’ financial needs and the combined Company’s expanded breadth of products and services. Noninterest income included:

Net unrealized losses on securities available for sale declined to $4.7 billion at March 31, 2009, from $9.9 billion at December 31, 2008. Of the improvement, $4.5 billion was due to the early adoption of Financial Accounting Standards Board (FASB) Staff Position (FSP) No. 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly, which clarified the use of trading prices in determining fair value for securities in illiquid markets, thus moderating the need to use distressed prices in valuing these securities in illiquid markets as we had done in prior periods. See “Current Accounting Developments” in this Report for more information on

FSP 157-4. The remaining $700 million of the improvement was due to declining interest rates and narrower credit spreads.

Noninterest expense was $11.82 billion in first quarter 2009, up from $5.44 billion in first quarter 2008, largely attributable to the Wachovia acquisition. Noninterest expense reflected our expanded geographic platform and capabilities in businesses such as retail brokerage, asset management and investment banking, which, like mortgage banking, typically include higher revenue-based incentive expense than the more traditional banking businesses. Our efficiency ratio was 56.2% in first quarter 2009.

We expect to generate $5 billion of annual merger-related expense savings, which will begin to emerge in the second quarter and are expected to be fully realized upon completion of the integration. We further expect additional efficiency initiatives to lower expenses over the remainder of 2009. After refining our initial models, we now expect total integration expense to be less than our original estimate of $7.9 billion and to be spread over the integration period rather than all by year-end 2009.

Net charge-offs in first quarter 2009 were $3.3 billion (1.54% of average total loans outstanding, annualized), including $371 million in the Wachovia portfolio, compared with $2.8 billion (2.69%) in fourth quarter 2008 and $1.5 billion (1.60%) in first quarter 2008. Wachovia loans accounted for under SOP 03-3 were written down to fair value at December 31, 2008, and accordingly charge-offs on that portfolio will only occur if the portfolio deteriorates subsequent to the acquisition. All first quarter 2009 charge-offs were on non-SOP 03-3 loans. Commercial and commercial real estate loan losses remained at relatively low levels reflecting the historically disciplined underwriting standards applied by Wells Fargo and the customer-relationship focus in this portfolio. Losses in residential real estate and credit cards rose modestly in the quarter, in line with expectations, while other credit losses, principally in indirect auto lending, declined due to seasonality and our risk reduction actions in indirect auto over the last two years.

As long as the U.S. economy remains weak, losses on the combined portfolio will increase. Over the last two years, we have taken and will continue to take actions to enable us to navigate through this current economic and credit cycle. In addition to the significant write-downs taken to reduce risk in the Wachovia portfolio at close, we ceased originations and are liquidating certain higher-risk, lower-return portfolios, such as Pick-a-Pay and legacy Wells Fargo indirect auto and liquidating home equity portfolios. In addition, during first quarter 2009, we incorporated Wells Fargo’s risk policies and procedures into Wachovia, which is essential to our ability to properly manage risk as we continue to meet our customers’ needs. We believe these risk reduction actions better position us for continued credit deterioration and economic headwinds.

The provision for credit losses was $4.6 billion in first quarter 2009, $8.4 billion in fourth quarter 2008 and $2.0 billion in first quarter 2008. The provision in first quarter 2009 included a $1.3 billion credit reserve build due to higher credit losses inherent in the loan portfolio. The allowance for credit losses, which consists of the allowance for loan losses and the reserve for unfunded credit commitments, was $22.8 billion (2.71% of total loans) at March 31, 2009, compared with $21.7 billion (2.51%) at December 31, 2008, and $6.0 billion (1.56%) at March 31, 2008. Wachovia’s allowance related to loans not within the scope of SOP 03-3 of $9.3 billion was carried over and was included in our allowance as of December 31, 2008.

Total nonaccrual loans were $10.52 billion (1.25% of total loans) at March 31, 2009, compared with $6.80 billion (0.79%) at December 31, 2008, and $3.26 billion (0.84%) at March 31, 2008. Nonaccrual loans exclude loans acquired from Wachovia accounted for under SOP 03-3. The $3.7 billion increase in nonaccrual loans from December 31, 2008, represented increases in both the commercial and retail segments, with $1.5 billion related to Wachovia. The increases in nonaccrual loans were concentrated in portfolios secured by real estate or with borrowers dependent on the housing industry. Total nonperforming assets (NPAs) were $12.61 billion (1.50% of total loans) at March 31, 2009, compared with $9.01 billion (1.04%) at December 31, 2008, and $4.50 billion (1.16%) at March 31, 2008. Foreclosed assets were $2.06 billion at March 31, 2009, $2.19 billion at December 31, 2008, and $1.22 billion at March 31, 2008.

We have strengthened our capital position in first quarter 2009. Tangible common equity (TCE) was $41.1 billion at quarter end, an increase of $4.5 billion. The ratio of TCE to tangible assets was 3.28%, up from 2.86% at December 31, 2008. TCE was 3.84% of risk-weighted assets. At March 31, 2009, Tier 1 capital was $89.0 billion and the Tier 1 capital ratio was 8.30%, up from 7.84% at December 31, 2008.

The Company and each of its subsidiary banks continued to remain well-capitalized. Our total risk-based capital (RBC) ratio at March 31, 2009, was 12.30% and our Tier 1 RBC ratio was 8.30%, exceeding the minimum regulatory guidelines of 8% and 4%, respectively, for bank holding companies. Our total RBC ratio was 11.83% and our Tier 1 RBC ratio was 7.84% at December 31, 2008. Our Tier 1 leverage ratio was 7.09% and 14.52% at March 31, 2009, and December 31, 2008, respectively, exceeding the minimum regulatory guideline of 3% for bank holding companies.

On May 7, 2009, the Federal Reserve confirmed that under its adverse stress test scenario the Company’s Tier 1 capital exceeded the minimum level needed for well-capitalized institutions. In conjunction with the stress test, the Company has agreed with the Federal Reserve to increase common equity by $13.7 billion by November 9, 2009. On May 8, 2009, the Company agreed to issue 341 million shares of its common stock at a price of $22 per share. Also on May 8, 2009, the underwriters in the offering exercised their option to purchase up to an additional 51.15 million shares of common stock from the Company at $22 per share to cover over-allotments. The Company will receive net proceeds of $8.4 billion from the offering including the exercise of the over-allotment option. The Company expects to satisfy the remainder of the capital requirement through profits and other internally generated sources. The Company can satisfy any part of the capital requirement by exchanging up to $13.7 billion of its $25 billion of Capital Purchase Program (CPP) funds for the Treasury’s Capital Assistance Program (CAP) on a dollar-for-dollar basis.

In first quarter 2009, we adopted the following new accounting pronouncements:

In addition, FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments, was issued by the FASB, but is not yet effective. Each of these pronouncements is described in more detail below.

FAS 161 changes the disclosure requirements for derivative instruments and hedging activities. It requires enhanced disclosures about how and why an entity uses derivatives, how derivatives and related hedged items are accounted for, and how derivatives and hedged items affect an entity’s financial position, performance and cash flows. We adopted FAS 161 for first quarter 2009 reporting. See Note 12 (Derivatives) to Financial Statements in this Report for complete disclosures under FAS 161. Because FAS 161 amends only the disclosure requirements for derivative instruments and hedged items, the adoption of FAS 161 does not affect our consolidated financial results.

FAS 160 requires that noncontrolling interests (previously referred to as minority interests) be reported as a component of equity in the balance sheet. Prior to adoption of FAS 160, they were classified outside of equity. This new standard also changes the way a noncontrolling interest is presented in the income statement such that a parent’s consolidated income statement includes amounts attributable to both the parent’s interest and the noncontrolling interest. FAS 160 requires a parent to recognize a gain or loss when a subsidiary is deconsolidated. The remaining interest is initially recorded at fair value. Other changes in ownership interest where the parent continues to have a majority ownership interest in the subsidiary are accounted for as capital transactions. FAS 160 was effective for us on January 1, 2009. Adoption is applied prospectively to all noncontrolling interests including those that arose prior to the adoption of FAS 160, with retrospective adoption required for disclosure of noncontrolling interests held as of the adoption date.

We hold a controlling interest in a joint venture with Prudential Financial, Inc. (Prudential). For more information, see “Contractual Obligations” in our 2008 Form 10-K. In connection with the adoption of FAS 160 on January 1, 2009, we reclassified Prudential’s noncontrolling interest to equity. Under the terms of the original agreement under which the joint venture was established between Wachovia and Prudential, each party has certain rights such that changes in our ownership interest can occur. Prudential has stated its intention to exercise its option to put its

noncontrolling interest to us at a date in the future, but has not yet done so. As a result of the issuance of FAS 160 and related interpretive guidance, along with this stated intention, on January 1, 2009, we increased the carrying value of Prudential’s noncontrolling interest in the joint venture to the estimated maximum redemption amount, with the offset recorded to additional paid-in capital.

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

FSP FAS 157-4 addresses measuring fair value under FAS 157 in situations where markets are inactive and transactions are not orderly. The FSP acknowledges that in these circumstances quoted prices may not be determinative of fair value. The FSP emphasizes, however, that even if there has been a significant decrease in the volume and level of activity for an asset or liability and regardless of the valuation technique(s) used, the objective of a fair value measurement has not changed. Prior to issuance of this FSP, FAS 157 had been interpreted by many companies, including Wells Fargo, to emphasize that fair value must be measured based on the most recently available quoted market prices, even for markets that have experienced a significant decline in the volume and level of activity relative to normal conditions and therefore could have increased frequency of transactions that are not orderly. Under the provisions of the FSP, price quotes for assets or liabilities in inactive markets may require adjustment due to uncertainty as to whether the underlying transactions are orderly. For inactive markets, we note there is little information, if any, to evaluate if individual transactions are orderly. Accordingly, we are required to estimate, based upon all available facts and circumstances, the degree to which orderly transactions are occurring. The FSP does not prescribe a specific method for adjusting transaction or quoted prices, however, it does provide guidance for determining how much weight to give transaction or quoted prices. Price quotes based upon transactions that are not orderly are not considered to be determinative of fair value and should be given little, if any, weight in measuring fair value. Price quotes based upon transactions that are orderly shall be considered in determining fair value and the weight given is based upon the facts and circumstances. If sufficient information is not available to determine if price quotes are based upon orderly transactions, less weight should be given to the price quote relative to other transactions that are known to be orderly.

The provisions of FSP FAS 157-4 are effective in second quarter 2009; however, as permitted under the pronouncement, we early adopted in first quarter 2009. Adoption of this pronouncement resulted in an increase in the valuation of securities available for sale of $4.5 billion ($2.8 billion after tax), which is included in other comprehensive income, and trading assets of $18 million, which is reflected in earnings. See “Critical Accounting Policies” in this Report for more information.

FSP FAS 115-2 and FAS 124-2 states that an other-than-temporary impairment (OTTI) write-down of debt securities, where fair value is below amortized cost, is triggered in circumstances where (1) an entity has the intent to sell a security, (2) it is more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis, or (3) the entity does not expect to recover the entire amortized cost basis of the security. If an entity intends to sell a security or if it is more likely than not the entity will be required to sell the security before recovery, an OTTI write-down is recognized in earnings equal to the entire difference between the security’s amortized cost basis and its fair value. If an entity does not intend to sell the security or it is not more likely than not that it will be required to sell the security before recovery, the OTTI write-down is separated into an amount representing the credit loss, which is recognized in earnings, and the amount related to all other factors, which is recognized in other comprehensive income. The provisions of this FSP are effective in second quarter 2009; however, as permitted under the pronouncement, we early adopted on January 1, 2009, and increased the beginning balance of retained earnings by $85 million ($53 million after tax) with a corresponding adjustment to accumulated other comprehensive income for OTTI recorded in previous periods on securities in our portfolio at January 1, 2009, that would not have been required had the FSP been effective for those periods.

EITF 03-6-1 requires that unvested share-based payment awards that have nonforfeitable rights to dividends or dividend equivalents be treated as participating securities and, therefore, included in the computation of earnings per share under the two-class method described in FAS 128,Earnings per Share. This pronouncement is effective on January 1, 2009, with retrospective adoption required. The adoption of EITF 03-6-1 did not have a material effect on our consolidated financial statements.

FSP FAS 107-1 and APB 28-1 requires disclosures about fair value of financial instruments for interim reporting periods as well as in annual financial statements. The provisions of the FSP are effective for interim reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. We will adopt this FSP for June 30, 2009, reporting. Because the FSP amends only the disclosure requirements related to the fair value of financial instruments, the adoption of the FSP will not affect our consolidated financial results.

Our significant accounting policies are fundamental to understanding our results of operations and financial condition because they require that we use estimates and assumptions that may affect the value of our assets or liabilities, and our financial results. Six of these policies are critical because they require management to make difficult, subjective and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions. These policies govern:

Management has reviewed and approved these critical accounting policies and has discussed these policies with the Audit and Examination Committee. These policies are described in “Financial Review – Critical Accounting Policies” and Note 1 (Summary of Significant Accounting Policies) to Financial Statements in our 2008 Form 10-K. Due to the adoption of FSP FAS 157-4, which affects the measurement of fair value of certain assets, principally securities and trading assets, we have updated and provided herein the policy on the fair value of financial instruments, as described below.

FAIR VALUE OF FINANCIAL INSTRUMENTS

We use fair value measurements to record fair value adjustments to certain financial instruments and to develop fair value disclosures. See our 2008 Form 10-K for the complete critical accounting policy related to fair value of financial instruments.

In connection with the adoption of FSP FAS 157-4, we developed policies and procedures to determine when the level and volume of activity for our assets and liabilities requiring fair value measurements have declined significantly relative to normal conditions. For items that use price quotes, such as certain security classes within securities available for sale, the degree of market inactivity and distressed transactions is estimated to determine the appropriate adjustment to the price quotes. The methodology we use to adjust the quotes generally involves weighting the price quotes and results of internal pricing techniques, such as the net present value of future expected cash flows (with observable inputs, where available) discounted at a rate of return market participants require. The more active and orderly markets for particular security classes were determined to be, the more weighting we assign to price quotes. The less active and the orderly markets were determined to be, the less weighting we assign to price quotes. Applying these policies to securities available for sale within the scope of the FSP of $40.0 billion (22% of the securities available-for-sale portfolio) at March 31, 2009, resulted in a $4.5 billion ($2.8 billion after tax) reduction in the net unrealized loss, which is reflected in equity. The more significant components of the $4.5 billion included $2.3 billion related to residential mortgage-backed securities and $1.3 billion related to commercial mortgage-backed securities. In addition, applying these policies to trading assets resulted in an $18 million increase in the fair value of certain trading assets, which is reflected in first quarter earnings.

Approximately 22% of total assets ($285.3 billion) at March 31, 2009, and 19% of total assets ($247.5 billion) at December 31, 2008, consisted of financial instruments recorded at fair value on a recurring basis. Assets for which fair values were measured using significant Level 3 inputs (before derivative netting adjustments) represented approximately 22% of these financial instruments (5% of total assets) at March 31, 2009, and approximately 22% (4% of total assets) at December 31, 2008. The fair value of the remaining assets were measured using valuation methodologies involving market-based or market-derived information, collectively Level 1 and 2 measurements.

In first quarter 2009, $5.6 billion of debt securities available for sale were transferred from Level 2 to Level 3 because significant inputs to the valuation became unobservable, largely due to reduced levels of market liquidity.

Approximately 2% of total liabilities ($20.6 billion) at March 31, 2009, and 2% ($18.8 billion) at December 31, 2008, consisted of financial instruments recorded at fair value on a recurring basis. Liabilities valued using Level 3 measurements (before derivative netting adjustments) were $8.6 billion and $9.3 billion at March 31, 2009, and December 31, 2008, respectively.

NET INTEREST INCOME

Net interest income is the interest earned on debt securities, loans (including yield-related loan fees) and other interest-earning assets minus the interest paid for deposits and long-term and short-term debt. The net interest margin is the average yield on earning assets minus the average interest rate paid for deposits and our other sources of funding. Net interest income and the net interest margin are presented on a taxable-equivalent basis to consistently reflect income from taxable and tax-exempt loans and securities based on a 35% federal statutory tax rate.

Net interest income on a taxable-equivalent basis was $11.55 billion in first quarter 2009, with approximately 40% contributed by Wachovia, and $5.81 billion in first quarter 2008. Net interest income reflected a strong combined net interest margin of 4.16%, due in part to continued growth in core deposits and deposit pricing discipline.

Average earning assets increased to $1.1 trillion in first quarter 2009 from $496.9 billion in first quarter 2008. Average loans increased to $855.6 billion in first quarter 2009 from $383.9 billion a year ago. Average mortgages held for sale increased to $31.1 billion in first quarter 2009 from $26.3 billion a year ago. Average debt securities available for sale increased to $160.4 billion in first quarter 2009 from $75.2 billion a year ago.

Core deposits are a low-cost source of funding and thus an important contributor to growth in net interest income and the net interest margin. Core deposits include noninterest-bearing deposits, interest-bearing checking, savings certificates, market rate and other savings, and certain foreign deposits (Eurodollar sweep balances). Average core deposits rose to $753.9 billion in first quarter 2009 from $317.3 billion in first quarter 2008, with over half of the increase from Wachovia, and funded 88% and 83% of average loans in first quarter 2009 and 2008, respectively. Total average retail core deposits, which exclude Wholesale Banking core deposits and retail mortgage escrow deposits, grew $362.1 billion to $590.5 billion for first quarter 2009 from $228.4 billion a year ago. Average mortgage escrow deposits were $24.7 billion in first quarter 2009, up $4.3 billion from $20.4 billion a year ago. Average savings certificates of deposits increased to $170.1 billion in first quarter 2009 from $41.9 billion a year ago and average noninterest-bearing checking accounts and other core deposit categories (interest-bearing checking and market rate and other savings) increased to $554.1 billion in first quarter 2009 from $250.0 billion a year ago. Total average interest-bearing deposits increased to $635.4 billion in first quarter 2009 from $258.4 billion a year ago.

The following table presents the individual components of net interest income and the net interest margin.

NONINTEREST INCOME

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 March 31, 2009, these assets totaled $1.53 trillion, including $474 billion from Wachovia, up from $1.13 trillion at March 31, 2008. Trust, investment and IRA fees are primarily based on a tiered scale relative to the market value of the assets under management or administration. The fees increased to $722 million in first quarter 2009 from $559 million a year ago.

We also receive commissions and other fees for providing services to full-service and discount brokerage customers. Generally, these fees include transactional commissions, which are based on the number of transactions executed at the customer’s direction, or asset-based fees, which are based on the market value of the customer’s assets. At March 31, 2009, brokerage balances totaled $910 billion, including $812 billion from Wachovia, compared with $126 billion at March 31, 2008. The fees increased to $1,493 million from $204 million a year ago.

Card fees increased to $853 million in first quarter 2009 from $558 million a year ago, predominantly due to $268 million in card fees from the Wachovia portfolio.

Mortgage banking noninterest income was $2,504 million in first quarter 2009, compared with $631 million a year ago. Net gains on mortgage loan origination/sales activities of $1,582 million in first quarter 2009 were up from $267 million a year ago. Business performance was very strong in first quarter 2009, reflecting strong refinance activity due to the low interest rate environment, with residential real estate originations of $101 billion compared with $66 billion a

year ago. The 1-4 family first mortgage unclosed pipeline was $100 billion (including $4 billion from Wachovia) at March 31, 2009, $71 billion (including $5 billion from Wachovia) at December 31, 2008, and $61 billion at March 31, 2008. For additional detail, see “Asset/Liability and Market Risk Management – Mortgage Banking Interest Rate and Market Risk” and Note 8 (Mortgage Banking Activities) and Note 13 (Fair Values of Assets and Liabilities) to Financial Statements in this Report.

Net gains on mortgage loan origination/sales activities include changes in the fair value of loans in the mortgage warehouse and additions to the mortgage repurchase reserve. Mortgage loans are repurchased based on standard representations and warranties. A $78 million increase in the repurchase reserve in first quarter 2009 from December 31, 2008, was due to higher defaults and loss severities and overall deterioration in the market. To the extent the market does not recover, the residential mortgage business could continue to have increased loss severity on repurchases, causing future increases in the repurchase reserve. In addition, there were $60 million in warehouse valuation adjustments in first quarter 2009 related to credit and liquidity losses. Due to the deterioration in the overall credit market and related secondary market liquidity challenges, losses on unsalable loans have been significant. Similar losses on unsalable loans could be possible in the future until the housing market recovers.

Within mortgage banking noninterest income, servicing income includes both changes in the fair value of MSRs during the period as well as changes in the value of derivatives (economic hedges) used to hedge the MSRs. Net servicing income in first quarter 2009 included an $875 million net MSRs valuation gain recorded in earnings (a $2.8 billion reduction in the fair value of the MSRs offset by a $3.7 billion hedge gain) and in first quarter 2008 included a $94 million net MSRs valuation gain ($1.8 billion reduction in the fair value of MSRs offset by a $1.9 billion hedge gain). Our portfolio of loans serviced for others was $1.85 trillion at March 31, 2009, and $1.86 trillion at December 31, 2008, which included $379 billion acquired from Wachovia. At March 31, 2009, the ratio of MSRs to related loans serviced for others was 0.74%.

Insurance revenue was $581 million in first quarter 2009, up from $504 million a year ago, primarily due to the addition of Wachovia.

Income from trading activities was $787 million in first quarter 2009, up from $103 million a year ago, with the increase largely from Wachovia. Approximately two-thirds of the income this quarter was from customer-related business, with much of the remainder from economic hedging. Trading results included $18 million in first quarter 2009 from the application of FSP FAS 157-4.

Net investment losses (debt and equity) totaled $276 million in first quarter 2009 and included other-than-temporary impairment write-downs of $516 million. Net losses on debt securities available for sale were $119 million in first quarter 2009, compared with net gains of $323 million a year ago. Net losses from equity investments were $157 million in first quarter 2009, compared with net gains of $313 million a year ago, which reflected the $334 million gain from our ownership interest in Visa, which completed its initial public offering in March 2008. For additional detail, see “Balance Sheet Analysis – Securities Available for Sale” in this Report.

NONINTEREST EXPENSE

Noninterest expense more than doubled to $11.8 billion in first quarter 2009 from a year ago, primarily due to the acquisition of Wachovia, which resulted in an expanded geographic platform and capabilities in businesses such as retail brokerage, asset management and investment banking, which, like mortgage banking, typically include higher revenue-based incentive expense than the more traditional banking businesses. FDIC and other deposit assessments increased to $338 million in first quarter 2009, due to additional assessments related to the FDIC Transaction Account Guarantee Program, compared with $8 million a year ago. See “Liquidity and Funding” in this Report for additional information on this program. Noninterest expense in first quarter 2009 included $122 million of additional insurance reserve at our captive mortgage reinsurance operation and $206 million of merger-related costs.

INCOME TAX EXPENSE

Our effective income tax rate was 33.8% in first quarter 2009, down from 34.9% in first quarter 2008. The decrease is primarily attributable to higher tax-exempt income and tax credits, partially offset by increased tax expense (with a comparable increase in interest income) associated with the purchase accounting for leveraged leases. Effective January 1, 2009, we adopted FAS 160, which changes the way noncontrolling interests are presented in the income statement such that the consolidated income statement includes amounts from both Wells Fargo interests and the noncontrolling interests. As a result, our effective tax rate is calculated by dividing income tax expense by income before income tax expense less the net income from noncontrolling interests.

OPERATING SEGMENT RESULTS

Wells Fargo defines its operating segments by product type and customer segment. As a result of the combination of Wells Fargo and Wachovia, management realigned its business segments into the following three lines of business: Community Banking; Wholesale Banking; and Wealth, Brokerage and Retirement Services. Our management accounting process measures the performance of the operating segments based on our management structure and is not necessarily comparable with other similar information for other financial services companies. We revised prior period information to reflect the realignment of our operating segments; however, because the acquisition was completed on December 31, 2008, Wachovia’s results are included in segment results beginning in 2009. For a more complete description of our operating segments, including additional financial information and the underlying management accounting process, see Note 17 (Operating Segments) to Financial Statements in this Report.

Community Banking offers a complete line of diversified financial products and services for consumers and small businesses including investment, insurance and trust services in 39 states and D.C., and mortgage and home equity loans in all 50 states and D.C. Wachovia added expanded product capability as well as expanded channels to better serve our customers. In addition, with the realignment of the operating segments, Community Banking now includes Wells Fargo Financial.

Community Banking net income increased to $1.84 billion in first quarter 2009 from $1.52 billion a year ago. The growth in net income and average assets for Community Banking was largely due to the addition of Wachovia businesses, as well as double-digit growth in legacy Wells Fargo businesses driven by strong balance sheet growth and mortgage banking income. Revenue increased to $13.95 billion from $8.20 billion a year ago. Net interest income increased to $8.50 billion in first quarter 2009 from $4.72 billion a year ago. Average loans increased to $552.8 billion in first quarter 2009 from $282.7 billion a year ago. Average core deposits increased to $538.0 billion in first quarter 2009 from $246.6 billion a year ago due to Wachovia, as well as double-digit growth in legacy Wells Fargo. Noninterest income increased to $5.46 billion in first quarter 2009 from $3.48 billion a year ago. Noninterest expense increased to $7.16 billion from $3.91 billion a year ago. The provision for credit losses increased to $4.00 billion in first quarter 2009 from $1.87 billion a year ago.

Wholesale Banking provides financial solutions to businesses across the United States with annual sales generally in excess of $10 million and financial institutions globally. Products include middle market banking, corporate banking, commercial real estate, treasury management, asset-based lending, insurance brokerage, foreign exchange, correspondent banking, trade services, specialized lending, equipment finance, corporate trust, investment banking, capital markets, and asset management. Wachovia added expanded product capabilities across the segment, including investment banking, mergers and acquisitions, equity trading, equity structured products, fixed-income sales and trading, and equity and fixed income research.

Wholesale Banking net income increased to $1.18 billion in first quarter 2009 from $483 million a year ago. The growth in net income and average assets for Wholesale Banking was largely due to the addition of Wachovia businesses. Revenue increased to a record $4.91 billion in first quarter 2009 from $2.18 billion a year ago. Net interest income increased to $2.37 billion in first quarter 2009 from $1.03 billion a year ago. Average loans increased to $271.9 billion in first

quarter 2009 from $100.8 billion a year ago. Average core deposits increased to $138.5 billion in first quarter 2009 from $68.2 billion a year ago. Noninterest income increased to $2.54 billion in first quarter 2009 from $1.15 billion a year ago, primarily due to Wachovia, as well as strong growth in service charges on deposits and loan fees. Noninterest expense increased to $2.53 billion in first quarter 2009 from $1.34 billion a year ago. The provision for credit losses increased to $545 million in first quarter 2009, from $161 million a year ago.

Wealth, Brokerage and Retirement Services provides a full range of financial advisory services to clients using a comprehensive planning approach to meet each client’s needs. The Wealth Management Group provides affluent and high net worth clients with a complete range of wealth management solutions including financial planning, private banking, credit, investment management and trust. Family Office Services meets the unique needs of the ultra high net worth customers. Retail brokerage’s financial advisors serve customers’ advisory, brokerage and financial needs as part of one of the largest full-service brokerage firms in the U.S. The Retirement Group provides retirement services for individual investors and is a national leader in 401(k) and pension record keeping. The addition of Wachovia in first quarter 2009 added the following businesses to this operating segment: Wachovia Securities (retail brokerage), Wachovia Wealth Management, including its family office business and Wachovia’s retirement services and reinsurance group.

Wealth, Brokerage and Retirement Services net income was $259 million in first quarter 2009 up from $93 million a year ago. The growth in net income and average assets for the segment is due to the addition of Wachovia businesses. Revenue increased to $2.64 billion in first quarter 2009 from $637 million a year ago. Net interest income increased to $737 million in first quarter 2009 from $154 million a year ago. Average loans increased to $46.7 billion in first quarter 2009 from $13.7 billion a year ago. The provision for credit losses was $25 million in first quarter 2009. Noninterest expense increased to $2.22 billion in first quarter 2009 from $485 million a year ago. First quarter 2009 noninterest expense includes $166 million of intangible amortization expense related to the Wachovia acquisition.

SECURITIES AVAILABLE FOR SALE

Securities available for sale consist of both debt and marketable equity securities. We hold debt securities available for sale primarily for liquidity, interest rate risk management and long-term yield enhancement. Accordingly, this portfolio consists primarily of very liquid, high-quality federal agency debt and privately issued mortgage-backed securities. At March 31, 2009, we held $173.3 billion of debt securities available for sale, with net unrealized losses of $4.1 billion, compared with $145.4 billion at December 31, 2008, including $63.7 billion acquired from Wachovia, with net unrealized losses of $9.8 billion. We also held $5.2 billion of marketable equity securities available for sale at March 31, 2009, with net unrealized losses of $646 million compared with $6.1 billion at December 31, 2008, including $3.7 billion acquired from Wachovia, with net unrealized losses of $160 million. Following application of purchase accounting to the Wachovia portfolio, the net unrealized losses in cumulative other comprehensive income at December 31, 2008, related entirely to the legacy Wells Fargo portfolio.

The decrease in net unrealized losses on debt securities available for sale to $4.1 billion at March 31, 2009, from $9.8 billion at December 31, 2008, was predominantly due to the early adoption of FSP FAS 157-4, which clarified the use of trading prices in determining fair value for securities in illiquid markets, thus moderating the need to use distressed prices in valuing these securities in illiquid markets as we had done in prior periods. The remainder of the change was due to declining interest rates and narrower credit spreads.

We analyze securities for other-than-temporary impairment (OTTI) on a quarterly basis, or more often if a potential loss-triggering event occurs. We recognize OTTI when it is probable that we will be unable to collect all amounts due according to the contractual terms of the security, and the fair value of the investment security is less than its amortized cost. The initial indication of OTTI for both debt and equity securities is a decline in the market value below the amount recorded for an investment, and the severity and duration of the decline. In determining whether an impairment is other than temporary, we consider the length of time and the extent to which the market value has been below cost, recent events specific to the issuer, including investment downgrades by rating agencies and economic conditions within its industry, and whether it is more likely than not that we will be required to sell the security before a recovery in value.

For marketable equity securities, in addition to the above factors, we also consider the issuer’s financial condition, capital strength and near-term prospects. For debt securities and for certain perpetual preferred securities, which are treated as debt securities for the purpose of OTTI analysis, 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, any change in agency ratings at evaluation date from acquisition date and any likely imminent action. For asset-backed securities, we consider the credit performance of the underlying collateral, including delinquency rates, cumulative losses to date, and the remaining credit enhancement compared to expected credit losses of the security.

For debt securities that are considered other-than-temporarily impaired and that we do not intend to sell and will not be required to sell prior to recovery of our amortized cost basis, we recognize OTTI in accordance with FSP FAS 115-2 and FAS 124-2, which we early adopted on January 1, 2009. Under this FSP, we separate the amount of the OTTI into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between a security’s amortized cost basis and the present value of expected future cash flows discounted at the security’s effective interest rate. The amount due to all other factors is recognized in other comprehensive income.

Of the first quarter 2009 OTTI write-downs of $516 million, $269 million related to debt securities and $247 million to equity securities. Under FSP FAS 115-2 and FAS 124-2, which we adopted this quarter, total OTTI on debt securities amounted to $603 million, which includes $263 million of credit-related OTTI and $6 million related to securities we intend to sell, both of which were recorded as part of gross realized losses, and $334 million recorded directly to other comprehensive income for non-credit related impairment on securities.

At March 31, 2009, we had approximately $6 billion of securities, primarily municipal bonds, that are guaranteed against loss by bond insurers. These securities are almost exclusively investment grade and were generally underwritten in accordance with our own investment standards prior to the determination to purchase, without relying on the bond insurer’s guarantee. These securities will continue to be monitored as part of our ongoing impairment analysis of our securities available for sale, but are expected to perform, even if the rating agencies reduce the credit ratings of the bond insurers.

The weighted-average expected maturity of debt securities available for sale was 4.9 years at March 31, 2009. Since 77% 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 is shown below.

MORTGAGE-BACKED SECURITIES

See Note 4 (Securities Available for Sale) to Financial Statements in this Report for securities available for sale by security type.

LOAN PORTFOLIO

A discussion of average loan balances is included in “Earnings Performance – Net Interest Income” on page 14 and a comparative schedule of average loan balances is included in the table on page 15.

The major categories of loans outstanding showing those subject to SOP 03-3 are presented in the following table.

In first quarter 2009, we refined certain of our initial purchase accounting, which resulted in changes to the portfolio of loans subject to SOP 03-3 and updates to the December 31, 2008, fair value estimates. Based on updates to the initial purchase accounting, $95.8 billion of loans were determined to be within the scope of SOP 03-3, a net increase of $1.9 billion from initial year-end estimates, and the fair value of these loans was $59.7 billion at December 31, 2008. These adjustments are reflected in the March 31, 2009, loan balances, along with first quarter activity, in the table above.

For further detail on SOP 03-3 loans see Note 1 (Summary of Significant Accounting Policies – Loans) to Financial Statements in the 2008 Form 10-K and Note 5 (Loans and Allowance for Credit Losses) to Financial Statements in this Report.

DEPOSITS

Deposits at March 31, 2009, totaled $797.3 billion, compared with $781.4 billion at December 31, 2008. A comparative detail of average deposit balances is provided on page 15. Total core deposits were $756.2 billion at March 31, 2009, up $10.8 billion from December 31, 2008. High-rate certificates of deposit (CDs) of $33.6 billion at legacy Wachovia matured in the quarter, including $13.2 billion from CD-only households. Higher-rate CDs are maturing and we are successfully retaining many of these deposits at today’s lower rates. The combination of noninterest-bearing and interest-bearing transaction and savings deposits increased 31% (annualized) to $570.7 billion at March 31, 2009, from $529.9 billion at December 31, 2008. Deposit performance continued to benefit from deeper market penetration, flight to quality and mortgage escrow activity.

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

OFF-BALANCE SHEET TRANSACTIONS WITH UNCONSOLIDATED ENTITIES

In the normal course of business, we enter into various types of on- and off-balance sheet transactions with special purpose entities (SPEs), which are corporations, trusts or partnerships that are established for a limited purpose. The majority of SPEs are formed in connection with securitization transactions. In a securitization transaction, assets from our balance sheet are transferred to an SPE, which then issues to investors various forms of interests in those assets and may also enter into derivative transactions. In a securitization transaction, we typically receive cash and/or other interests in an SPE as proceeds for the assets we transfer. Also, in certain transactions, we may retain the right to service the transferred receivables and to repurchase those receivables from the SPE if the outstanding balance of the receivables falls to a level where the cost exceeds the benefits of servicing such receivables.

In connection with our securitization activities, we have various forms of ongoing involvement with SPEs, which may include:

The SPEs we use are primarily either qualifying SPEs (QSPEs), which are not consolidated if the criteria described below are met, or variable interest entities (VIEs). To qualify as a QSPE, an entity must be passive and must adhere to significant limitations on the types of assets and derivative instruments it may own and the extent of activities and decision making in which it may engage. For example, a QSPE’s activities are generally limited to purchasing assets, passing along the cash flows of those assets to its investors, servicing its assets and, in certain transactions, issuing liabilities. Among other restrictions on a QSPE’s activities, a QSPE may not actively manage its assets through discretionary sales or modifications.

A VIE is an entity that has either a total equity investment that is insufficient to permit the entity to finance its activities without additional subordinated financial support or whose equity investors lack the characteristics of a controlling financial interest. A VIE is consolidated by its primary beneficiary, which is the entity that, through its variable interests, absorbs the majority of a VIE’s variability. A variable interest is a contractual, ownership or other interest that changes with fluctuations in the fair value of the VIE’s net assets.

The following table presents our significant continuing involvement with QSPEs and unconsolidated VIEs.

QUALIFYING SPECIAL PURPOSE ENTITIES AND UNCONSOLIDATED VARIABLE INTEREST ENTITIES

The table above does not include SPEs and unconsolidated VIEs where our only involvement is in the form of investments in trading securities, investments in securities available for sale or loans underwritten by third parties, or administrative or trustee services. Also not included are investments accounted for in accordance with the AICPA Investment Company Audit Guide, investments accounted for under the cost method and investments accounted for under the equity method.

In the table above, the column titled “Total entity assets” represents the total assets of unconsolidated SPEs. “Carrying value” is the amount in our consolidated balance sheet related to our involvement with the unconsolidated SPEs. “Maximum exposure to loss” from our involvement with off-balance sheet entities is a required disclosure under generally accepted accounting principles and represents the estimated loss that would be incurred under an assumed hypothetical circumstance, despite its extremely remote possibility, where the value of our interests and any associated collateral declines to zero, without any consideration of recovery or offset from any economic hedges. Accordingly, this required disclosure is not an indication of expected loss.

For more information on securitizations, including sales proceeds and cash flows from securitizations, see Note 7 (Securitizations and Variable Interest Entities) to Financial Statements in this Report.

We also have significant involvement with SPEs where the entity holding a majority of the voting interests consolidates the SPE. Wells Fargo Home Mortgage (Home Mortgage), in the ordinary course of business, originates 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. through an established line of credit and are subject to specified underwriting criteria. The total assets of these mortgage origination joint ventures were approximately $111 million and $46 million at March 31, 2009, and December 31, 2008, respectively. We provide liquidity to these joint ventures in the form of outstanding lines of credit and, at March 31, 2009, and December 31, 2008, these liquidity commitments totaled $128 million and $135 million, respectively.

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 with title, escrow, appraisal and other real estate-related services. Our fraud prevention services partnership facilitates the exchange of information between financial services organizations to detect and prevent fraud. Total assets of our real estate lending joint ventures and fraud prevention services partnership were approximately $150 million and $132 million at March 31, 2009, and December 31, 2008, respectively.

CREDIT RISK MANAGEMENT PROCESS

Our credit risk management process provides for decentralized management and accountability by our lines of business. Our overall credit process includes comprehensive credit policies, judgmental or statistical credit underwriting, frequent and detailed risk measurement and modeling, extensive credit training programs, and a continual loan review and audit process. In addition, regulatory examiners review and perform detailed tests of our credit underwriting, loan administration and allowance processes. We continually evaluate and modify our credit policies to address unacceptable levels of risk as they are identified.

As part of the Wachovia acquisition, we acquired residential first and home equity loans that are very similar to the Wells Fargo core originated portfolio. We also acquired the Pick-a-Pay option ARM first mortgage portfolio. The nature of this product creates a potential opportunity for negative amortization. As part of our purchase accounting activities, the option ARM loans with the highest probability of default were identified as SOP 03-3. See “Pick-a-Pay Portfolio” in this Report for additional detail.

The deterioration in specific segments of the Home Equity portfolios required a targeted approach to managing these assets. A liquidating portfolio, consisting of home equity loans generated through third party wholesale channels not behind a Wells Fargo first mortgage, and home equity loans acquired through correspondents, was identified. While the $9.9 billion of loans in this liquidating portfolio represented about 1% of total loans outstanding at March 31, 2009, these loans represented some of the highest risk in the $128.9 billion Home Equity portfolios, with a loss rate of 9.27% compared with 2.09% for the core portfolio. The loans in the liquidating portfolio are largely concentrated in geographic markets that have experienced the most abrupt and steepest declines in housing prices. The core portfolio was $119.1 billion at March 31, 2009, of which 97% was originated through the retail channel, and approximately 16% of the outstanding balance was in a first lien position. The table on the following page includes the credit attributes of these two portfolios.

HOME EQUITY PORTFOLIO (1)

We acquired the Pick-a-Pay loan portfolio from Wachovia. This is a liquidating portfolio as we stopped originating new Pick-a-Pay loans in 2008. At March 31, 2009, this portfolio, which excludes equity lines of credit, had an unpaid principal balance of $115.0 billion and a carrying value of $93.2 billion. The carrying value is net of $22.0 billion of purchase accounting net write-downs to reflect SOP 03-3 loans at fair value and a $215 million increase to reflect all other loans at a market rate of interest.

Pick-a-Pay loans are home mortgages on which the customer has the option each month to select from among four payment options: (1) a minimum payment as described below, (2) an interest-only payment, (3) a fully amortizing 15-year payment, or (4) a fully amortizing 30-year payment. Approximately 78% of the Pick-a-Pay portfolio has payment options calculated using a monthly adjustable interest rate; the rest of the portfolio is fixed rate.

The minimum monthly payment for substantially all of our Pick-a-Pay loans is reset annually. The new minimum monthly payment amount usually cannot increase by more than 7.5% of the then-existing principal and interest payment amount. The minimum payment may not be sufficient to pay the monthly interest due and in those situations a loan on which the customer has made a minimum payment is subject to “negative amortization,” where unpaid interest is

added to the principal balance of the loan. The amount of interest that has been added to a loan balance is referred to as “deferred interest.” Our Pick-a-Pay customers have been fairly constant in their utilization of the minimum payment option. At March 31, 2009, and December 31, 2008, customers representing 51% of the loan balances with the payment options feature elected the minimum payment option.

Deferral of interest on a Pick-a-Pay loan may continue as long as the loan balance remains below a pre-defined principal cap, which is based on the percentage that the current loan balance represents to the original loan balance. Loans with an original loan-to-value (LTV) ratio equal to or below 85% have a cap of 125% of the original loan balance, and these loans represent substantially all the Pick-a-Pay portfolio. Loans with an original LTV ratio above 85% have a cap of 110% of the original loan balance. Most of the Pick-a-Pay loans on which there is a deferred interest balance re-amortize (the monthly payment amount is reset or “recast”) on the earlier of the date when the loan balance reaches its principal cap, or the 10-year anniversary of the loan. There exists a small population of Pick-a-Pay loans for which recast occurs at the five-year anniversary. After a recast, the customers’ new payment terms are reset to the amount necessary to repay the balance over the remainder of the original loan term.

Based on assumptions of a flat rate environment, if all eligible customers elect the minimum payment option 100% of the time and no balances prepay, we would expect the following balance of loans to recast based on reaching the principal cap: $4 million in the remaining three quarters of 2009, $9 million in 2010, $11 million in 2011 and $32 million in 2012. In first quarter 2009, the amount of loans recast based on reaching the principal cap was de minimus. In addition, we would expect the following balance of ARM loans having a payment change based on the contractual terms of the loan to recast: $20 million in the remaining three quarters of 2009, $51 million in 2010, $70 million in 2011 and $128 million in 2012. A payment change recast occurred on $4 million of loans during first quarter 2009.

Included in the Pick-a-Pay portfolio were loans accounted for under SOP 03-3 with a total unpaid principal balance of $61.6 billion and a carrying value of $39.7 billion at March 31, 2009. Loans that we acquired from Wachovia with evidence of credit quality deterioration since origination and for which it was probable at the date of the Wachovia acquisition that we will be unable to collect all contractually required payments are accounted for under SOP 03-3. SOP 03-3 requires that acquired credit-impaired loans be recorded at fair value and prohibits carrying over of the related allowance in the initial accounting.

The table on the following page reflects the geographic distribution of the Pick-a-Pay portfolio broken out between SOP 03-3 loans and all other loans. In stressed housing markets with declining home prices and increasing delinquencies, the LTV ratio is a key metric in predicting future loan performance, including charge-offs. Because SOP 03-3 loans are carried at fair value, the carrying value LTV ratio for an SOP 03-3 loan will be lower as compared to the LTV based on the unpaid principal. For informational purposes, we have included the ratio of the carrying value to the current collateral value for SOP 03-3 loans in the following table.

PICK-A-PAY PORTFOLIO

To maximize return and allow flexibility for customers to avoid foreclosure, we have in place several loss mitigation strategies for our Pick-a-Pay loan portfolio. We contact customers who are experiencing difficulty and may in certain cases modify the terms of a loan based on a customer’s documented income and other circumstances.

We also have in place proactive steps to work with customers to refinance or restructure their Pick-a-Pay loans into other loan products. For customers at risk, we will offer combinations of term extensions of up to 40 years, interest rate reductions, charge no interest on a portion of the principal for some period of time and, in geographies with substantial property value declines, we will even offer permanent principal reductions. We expect to continually reassess our loss mitigation strategies and may adopt additional strategies in the future.

Wells Fargo Financial originates real estate secured debt consolidation loans, and both prime and non-prime auto secured loans, unsecured loans and credit cards.

Wells Fargo Financial had $28.8 billion and $29.1 billion in real estate secured loans at March 31, 2009, and December 31, 2008, respectively. Of this portfolio, $1.8 billion for each period is considered prime based on secondary market standards. The remaining portfolio is non-prime but has been originated with standards that effectively mitigate credit risk. It was originated through our retail channel with documented income, LTV limits based on credit quality and property characteristics, and risk-based pricing. In addition, the loans were originated without teaser rates, interest-only or negative amortization features. Credit losses in the portfolio have increased in the current economic environment compared with historical levels, but performance remained similar to prime portfolios in the industry with overall credit losses in first quarter 2009 of 2.39% (annualized) on the entire portfolio. Of the portfolio, $9.5 billion at

March 31, 2009, was originated with customer FICO scores below 620, but these loans have further restrictions on LTV and debt-to-income ratios to limit the credit risk.

Wells Fargo Financial also had $21.6 billion and $23.6 billion in auto secured loans and leases at March 31, 2009, and December 31, 2008, respectively, of which $5.8 billion and $6.3 billion, respectively, were originated with customer FICO scores below 620. Net charge-offs in this portfolio in first quarter 2009 were 5.11% (annualized) for FICO scores of 620 and above, and 6.88% (annualized) for FICO scores below 620. Of this portfolio, $16.3 billion represented loans and leases originated through its indirect auto business, which Wells Fargo Financial ceased originating near the end of 2008.

Wells Fargo Financial had $7.9 billion and $8.4 billion in unsecured loans and credit card receivables at March 31, 2009, and December 31, 2008, respectively, of which $1.2 billion and $1.3 billion, respectively, was originated with customer FICO scores below 620. Net charge-offs in this portfolio in first quarter 2009 were 12.97% (annualized) for FICO scores of 620 and above, and 19.58% (annualized) for FICO scores below 620. Wells Fargo Financial has been actively tightening credit policies and managing credit lines to reduce exposure given current economic conditions.

The following table shows the comparative data for nonaccrual loans and other nonperforming assets. We generally place loans on nonaccrual status when: