XNYS:WNAPR Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

Table of Contents

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

   For the quarterly period ended March 31, 2012

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                                 

Commission file number 1-31557

 

 

Wachovia Preferred Funding Corp.

(Exact name of registrant as specified in its charter)

 

Delaware

  56-1986430    

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer    

Identification No.)      

90 South 7th Street, 13th Floor

Minneapolis, Minnesota 55402

(Address of principal executive offices)

(Zip Code)

(855) 825-1437

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.

 

Large accelerated filer  ¨   Accelerated filer ¨   Non-accelerated filer  x   Smaller reporting company  ¨
   

(Do not check if a smaller

  reporting company.)

 

Indicate by check mark whether the registrant is a shell company (defined in Rule 12b-2 of the Exchange Act).  Yes ¨  No x

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY

PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.  Yes ¨  No ¨

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

As of April 30, 2012, there were 99,999,900 shares of the registrant’s common stock outstanding.

 

 


Table of Contents

FORM 10-Q

CROSS-REFERENCE INDEX

 

PART I

     Financial Information   
Item 1.      Financial Statements      Page   
     Consolidated Statement of Income      24   
     Consolidated Balance Sheet      25   
     Consolidated Statement of Changes in Stockholders’ Equity      26   
     Consolidated Statement of Cash Flows      27   
     Notes to Financial Statements   
    

1   -   Summary of Significant Accounting Policies

     28   
    

2   -   Loans and Allowance for Credit Losses

     29   
    

3   -   Derivatives

     42   
    

4   -   Fair Values of Assets and Liabilities

     43   
    

5   -   Common and Preferred Stock

     45   
    

6   -   Transactions with Related Parties

     47   
Item 2.     

Management’s Discussion and Analysis of Financial Condition and
Results of Operations (Financial Review)

  
     Summary Financial Data      2   
     Overview      3   
     Earnings Performance      5   
     Balance Sheet Analysis      7   
     Risk Management      8   
     Critical Accounting Policy      20   
     Current Accounting Developments      20   
     Forward-Looking Statements      21   
     Risk Factors      22   
Item 3.      Quantitative and Qualitative Disclosures About Market Risk      18   
Item 4.      Controls and Procedures      23   
PART II      Other Information   
Item 1.      Legal Proceedings      49   
Item 1A.      Risk Factors      49   
Item 2.      Unregistered Sales of Equity Securities and Use of Proceeds      49   
Item 6.      Exhibits      49   
Signature      50   
Exhibit Index      49   

 

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Table of Contents

PART I – FINANCIAL INFORMATION

Summary Financial Data

             
                                       
          

Quarter ended

          % Change
March 31, 2012
from
 
(in thousands, except per share data)          Mar. 31,  
2012  
   

Dec. 31,

2011

     Mar. 31,
2011
           Dec. 31,
2011
    Mar. 31,
2011
 

For the period

                  

Net income

   $      150,015          141,562         210,867            6   %      (29

Net income available to common stockholders

        100,429          94,669         164,921            6        (39

Diluted earnings per common share

        1.00          0.95         1.65            5        (39

Profitability ratios (annualized)

                  

Return on average assets

        4.40       4.08         5.19            8        (15

Return on average stockholders’ equity

        4.45          4.11         5.26            8        (15

Average stockholders’ equity to assets

        98.70          99.31         98.71            -        -   

Dividend payout ratio

        133.00          155.33         128.02            (14     4   

Total revenue

   $      217,276          230,234         280,800            (6     (23

Average loans

            12,259,816          12,472,898         14,850,696            (2     (17

Average assets

        13,726,605          13,770,915         16,482,360            -        (17

Net interest margin

        6.26       6.55         6.92            (4     (10

Net loan charge-offs

   $      53,173          50,707         65,322            5        (19

As a percentage of average total loans (annualized)

        1.74       1.61         1.78            8        (2

At period end

                  

Loans, net of unearned income

   $      12,639,638          12,543,776         14,286,152            1        (12

Allowance for loan losses

        309,913          313,762         389,310            (1     (20

As a percentage of total loans

        2.45       2.50         2.73            (2     (10

Assets

   $      13,679,834          13,534,395         15,656,496            1        (13

Total stockholders’ equity

        13,452,872          13,502,443         15,562,794            -        (14

Total nonaccrual loans and foreclosed assets

        414,133          356,019         363,226            16        14   

As a percentage of total loans

        3.28       2.84         2.54            15        29   

Loans 90 days or more past due and still accruing (1)

   $      21,771          38,096         27,182            (43     (20
                                                      

 

(1) The carrying value of PCI loans contractually 90 days or more past due is excluded. These PCI loans are considered to be accruing due to the existence of the accretable yield and not based on consideration given to contractual interest payments.

 

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This Report on Form 10-Q for the quarter ended March 31, 2012, including 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 materially from our forecasts and expectations due to several factors, some of which are discussed in the “Forward-Looking Statements” section in this Report. Some of these factors are also described in the Financial Statements and related Notes. For a discussion of other important factors, refer to the “Risk Factors” section in this Report and to the “Risk Factors” section in our Annual Report on Form 10-K for the year ended December 31, 2011 (2011 Form 10-K), filed with the Securities and Exchange Commission (SEC) and available on the SEC’s website at www.sec.gov and on Wells Fargo’s website, www.wellsfargo.com/invest_relations/filings/preferred-funding.

“Wachovia Funding”, “we”, “our” and “us” refer to Wachovia Preferred Funding Corp. “Wachovia Preferred Holding” refers to Wachovia Preferred Funding Holding Corp., the “Bank” refers to Wells Fargo Bank, National Association including predecessor entities, “Wachovia” refers to Wachovia Corporation, a North Carolina corporation, and “Wells Fargo” refers to Wells Fargo & Company.

Financial Review

Overview

 

 

Wachovia Funding is engaged in acquiring, holding and managing domestic real estate-related assets and other authorized investments that generate net income for distribution to our shareholders. We are classified as a real estate investment trust (REIT) for income tax purposes. As of March 31, 2012, we had $13.7 billion in assets, which included $12.6 billion in loans.

We are a direct subsidiary of Wachovia Preferred Holding and an indirect subsidiary of Wells Fargo and the Bank. At March 31, 2012, the Bank was considered “well-capitalized” under risk-based capital guidelines issued by federal banking regulators.

REIT Tax Status

For the tax year ending December 31, 2012, we expect to be taxed as a REIT, and we intend to comply with the relevant provisions of the Code to be taxed as a REIT. These provisions for qualifying as a REIT for federal income tax purposes are complex, involving many requirements, including among others, distributing the majority of our earnings to shareholders and satisfying certain asset, income and stock ownership tests. To the extent we meet those provisions, with the exception of the income of our taxable REIT subsidiary, we will not be subject to federal income tax on net income. We currently believe that we continue to satisfy each of these requirements and therefore continue to qualify as a REIT. We continue to monitor each of these complex tests.

In the event we do not continue to qualify as a REIT, we believe there should be minimal adverse effect of that characterization to us or to our shareholders:

   

From a shareholder’s perspective, the dividends we pay as a REIT are ordinary income not eligible for the dividends received deduction for corporate shareholders or for the favorable maximum 15% rate applicable to qualified dividends received by non-corporate taxpayers. If we were not a REIT, dividends we pay generally would qualify for the dividends

   

received deduction and the favorable tax rate applicable to non-corporate taxpayers.

   

In addition, we would no longer be eligible for the dividends paid deduction, thereby creating a tax liability for us. Wells Fargo agreed to make, or cause its subsidiaries to make, a capital contribution to us equal in amount to any income taxes payable by us. Therefore, we believe a failure to qualify as a REIT would not result in any net capital impact to us.

Financial Performance

Our first quarter 2012 results declined from first quarter 2011 due to a year over year earnings decline in average earning assets. Our first quarter 2012 net income was $150.0 million compared with $210.9 million in first quarter 2011. Diluted earnings per common share were $1.00, compared with $1.65 from a year ago. Our net income decline from first quarter 2011 was primarily driven by lower interest and noninterest income, which more than offset a lower provision for credit losses and lower noninterest expense. The lower interest income was driven by a decrease in average balances of interest-earning assets and in average yield on total interest-earning assets.

Loans

Total loans, which consist of loan participation interests, were $12.6 billion at March 31, 2012, up slightly from $12.5 billion at December 31, 2011. Loans represented approximately 92% and 93% of assets at March 31, 2012 and December 31, 2011, respectively. We continued reinvesting loan pay-downs in first quarter 2012 through a purchase of $943.5 million of consumer loans from the Bank. In first quarter 2011, we did not purchase loans from the Bank. Our board of directors declared a special capital distribution of $2.5 billion to holders of our common stock in first quarter 2011 that reduced relatively high levels of cash on our balance sheet, in order to continue to qualify for the exemption from registration under the Investment Company Act. If in future periods we do not reinvest loan pay-downs at anticipated levels by purchasing loans, management may request our board of directors to consider an additional return of capital to holders of our common stock.

 

 

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Purchased credit-impaired (PCI) loans were less than 1 percent of total loans at both March 31, 2012 and December 31, 2011. See Note 1 (Summary of Significant Accounting Policies – Loans) in our 2011 Form 10-K for additional information.

In first quarter 2012, in accordance with Interagency Supervisory Guidance on Allowance for Loan and Lease Losses Estimation Practices for Loans and Lines of Credit Secured by Junior Liens on 1-4 Family Residential Properties issued by bank regulators on January 31, 2012 (Interagency Guidance), we aligned our nonaccrual reporting so that a junior lien is reported as a nonaccrual loan if the related first lien is 120 days past due or is in the process of foreclosure. This action increased our nonaccrual loans by $55.2 million resulting in nonaccrual loans of $407.4 million at March 31, 2012 up from $349.1 million at December 31, 2011. See the “Risk Management – Credit Risk Management – Nonperforming Assets” section in this report for more information.

We believe it is important to maintain a well controlled operating environment and manage risks inherent in our business. We manage our credit risk by setting what we believe are sound credit policies for acquired loans, while monitoring and reviewing the performance of our loan portfolio.

Capital Distributions

In first quarter 2012, our board of directors declared distributions totaling $49.6 million to holders of our preferred securities, which included $13.6 million in dividends payable on April 2, 2012 to our Series A preferred securities held by non-affiliated investors. Distributions on preferred securities were $45.9 million in first quarter 2011, which included $13.6 million in dividends on our Series A preferred securities.

In first quarter 2012, our board of directors also declared distributions totaling $150.0 million to holders of our common stock. Distributions to holders of our common stock totaled $2.7 billion in first quarter 2011, which included $224.0 million in dividends and a $2.5 billion special capital distribution.

 

 

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Earnings Performance

 

 

Net Income Available to Common Stockholders

We earned net income available to common stockholders of $100.4 million and $164.9 million in first quarter 2012 and 2011, respectively. The decrease in year over year first quarter net income was primarily attributable to lower net interest income.

Interest Income

Interest income of $216.9 million in first quarter 2012 compared with $280.3 million a year ago. The decrease from 2011 relates to lower average interest-earning assets and lower average yield on total interest-earning assets. The average yield on total interest-earning assets was 6.26% in first quarter 2012 compared with 6.92% in first quarter 2011. The overall decline in the average yield on the combined consumer and commercial loan portfolio was primarily attributable to a decline in the accretion of discounts on purchased consumer loans. In first quarter 2012 and 2011,

interest income included discount accretion of $38.7 million and $67.5 million, respectively. The decrease in discount accretion was primarily driven by lower loan pay-downs and pay-offs in first quarter 2012 compared to first quarter 2011 and a decrease in average discount balances year-over-year.

    Average consumer loans decreased $2.4 billion to $11.0 billion compared with the first quarter of 2011 while average commercial loans decreased $236.3 million to $1.3 billion in the same period due to pay-downs, charge-offs and loan sales. To the extent we reinvest loan pay-downs or make purchases, we anticipate that we will acquire consumer and commercial real-estate secured loans and other REIT-eligible assets. See the interest rate risk management section under “Risk Management” for more information on interest rates and interest income.

    Table 1 presents the components of earning assets and related average yield to provide an analysis of year-over-year changes that influenced interest income.

 

 

Table 1: Interest Income

 

 

 
     Quarter ended March 31,  
                  

 

    2012

                      2011  
  

 

 

   

 

 

 

(in thousands)

    

 

Average

balance

  

  

    
 
Interest
income
  
  
     Yields       

 

Average

balance

  

  

    
 
Interest
income
  
  
         Yields   

 

 

 

Commercial loans

   $ 1,294,510         7,771         2.41    $ 1,530,766         8,973         2.38 

Real estate 1-4 family

     10,965,306         208,523         7.62         13,319,930         271,180         8.23    

Interest-bearing deposits in banks and other interest-earning assets

     1,631,314         624         0.15         1,513,799         189         0.05    
  

 

 

   

 

 

    

Total interest-earning assets

   $           13,891,130         216,918         6.26    $           16,364,495         280,342         6.92 

 

 

 

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Table of Contents

Interest Expense

Wachovia Funding has a $1.0 billion line of credit with the Bank, and our subsidiaries Wachovia Real Estate Investment Corp. and Wachovia Preferred Realty, LLC (WPR) have lines of credit with the Bank of $1.0 billion and $200.0 million, respectively. Based on sufficient levels of cash and cash equivalents, we did not borrow on our line of credit in first quarter 2012 or 2011; accordingly, we did not incur interest expense during these periods.

Provision for Credit Losses

The provision for credit losses was $51.3 million in first quarter 2012 compared with $52.5 million in first quarter 2011. The first quarter 2012 decrease in the provision for credit losses primarily resulted from lower net charge-offs, partially offset by a decrease in the level of allowance release in first quarter 2012 compared with first quarter 2011. The decrease in charge-offs was primarily driven by improvement in consumer delinquency levels as well as lower loan balances. Please refer to the “—Balance Sheet Analysis and Risk Management—Allowance for Credit Losses” sections in this Report for additional information on the allowance for loan losses.

Noninterest Income

Noninterest income totaled $360 thousand in first quarter 2012 compared with $460 thousand in first quarter 2011, which included a $113 thousand gain on loan sales to affiliate. Noninterest income also includes gains on interest rate swaps of $56 thousand in first quarter 2012 compared with gains of $110 thousand in first quarter 2011. Our interest rate swaps lose value in an increasing rate environment and gain value in a declining rate environment. The interest rate swaps terminate in June 2012.

Noninterest Expense

Noninterest expense totaled $15.9 million in first quarter 2012 compared with $17.4 million in the same period a year ago. Noninterest expense primarily consists of loan servicing costs, and to a lesser extent, management fees, foreclosed assets expense and other expenses.

    Loan servicing costs decreased $2.2 million to $10.8 million in first quarter 2012, which reflected a decrease in the commercial and consumer loan portfolios. These costs are driven by the size and mix of our loan portfolio.

    Management fees were $1.9 million in first quarter 2012 compared with $1.2 million in first quarter 2011. The increase in management fees related to inclusion of certain technology system and support expenses in the expense base subject to allocation which were not allocated in first quarter 2011. Management fees represent reimbursements for general overhead expenses paid on our behalf.

    Foreclosed assets expense was $2.3 million in first quarter 2012 and $2.5 million in first quarter 2011.

Income Tax Expense

Income tax expense, which is based on the pre-tax income of WPR, our taxable REIT subsidiary, was $89 thousand and $92 thousand in first quarter 2012 and 2011, respectively. WPR holds our interest rate swaps as well as certain cash investments.

 

 

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Table of Contents

Balance Sheet Analysis

 

 

Total Assets

Our assets primarily consist of commercial and consumer loans, although we have the authority to hold assets other than loans. Total assets were $13.7 billion at March 31, 2012, compared with $13.5 billion at December 31, 2011. The increase in total assets was primarily attributable to a $49.3 million increase in cash and cash equivalents and a $95.9 million increase in loans, net of unearned income. Loans, net of unearned income were 92% of total assets at March 31, 2012, compared with 93% at December 31, 2011.

Cash and Cash Equivalents

Cash and cash equivalents was $1.2 billion at March 31, 2012 and December 31, 2011. In first quarter 2012, we reinvested loan pay-downs in loan participations by purchasing $943.5 million of consumer loans from the Bank.

Loans

Loans, net of unearned income increased $95.9 million to $12.6 billion at March 31, 2012, compared with $12.5 billion at December 31, 2011, primarily reflecting a loan purchase partially offset by pay-downs, charge-offs and loan sales across the entire portfolio. In first quarter 2012, we purchased consumer loans from the Bank at an estimated fair value of $943.5 million. We did not purchase loans in first quarter 2011. At March 31, 2012 and December 31, 2011, consumer loans represented 90% and 89% of loans, respectively, and commercial loans represented the balance of our loan portfolio.

Allowance for Loan Losses

The allowance for loan losses decreased $3.9 million to $309.9 million at March 31, 2012, from $313.8 million at December 31, 2011. The decrease in the allowance is due to lower levels of inherent credit loss in the portfolio compared with prior year-end levels. The improvement in credit quality across the commercial and consumer portfolios reflected lower levels of delinquency.

    At March 31, 2012, the allowance for loan losses included $290.2 million for consumer loans and $19.7 million for commercial loans. The total allowance reflects management’s estimate of credit losses inherent in the loan portfolio at the balance sheet date. The “—Risk Management—Allowance for Credit Losses” section in this Report describes how management estimates the allowance for loan losses and the allowance for unfunded credit commitments.

Interest Rate Swaps

Interest rate swaps are carried at fair value, which resulted in a net asset position of $1.0 million at both March 31, 2012 and December 31, 2011. The contracts terminate in June 2012.

Accounts Receivable/Payable—Affiliates, Net

The accounts payable and receivable from affiliates result from intercompany transactions related to net loan pay-downs, interest receipts, and other transactions with the Bank.

Dividends Payable—Affiliates

Dividends payable – affiliates was $186.1 million at March 31, 2012, which represents first quarter 2012 accrued dividends payable primarily to Wachovia Preferred Holding, these dividends were paid on April 2, 2012.

 

 

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Risk Management

 

 

We use Wells Fargo’s risk management framework to manage our credit, interest rate, market and liquidity risks.

For more information about how we manage these risks, see the “Risk Management” section in our 2011 Form 10-K. The discussion that follows is intended to provide an update on these risks.

Loans represent the largest component of our balance sheet and their related credit risk is among the most significant risks we manage. We define credit risk as the risk of loss associated with a borrower or counterparty default (failure to meet obligations in accordance with agreed upon terms).

Credit Risk Management

Table 2: Total Loans Outstanding by Portfolio

Segment and Class of Financing Receivable

 

(in thousands)

  

March 31,

2012 

    

Dec. 31,

2011 

 

Commercial:

     

Commercial and industrial

   $ 281,512          287,174    

Real estate mortgage

     924,465          1,015,087    

Real estate construction

     39,821          45,887    

 

Total commercial

     1,245,798          1,348,148    

Consumer:

     

Real estate 1-4 family first mortgage

     8,124,256          7,945,746    

Real estate 1-4 family junior lien mortgage

     3,269,584          3,249,882    

Total consumer

     11,393,840          11,195,628    

 

Total loans

   $ 12,639,638          12,543,776    

The discussion that follows provides analysis of the risk elements of our various loan portfolios and updates our credit risk management and measurement practices as appropriate. See Note 2 (Loans and Allowance for Credit Losses) to Financial Statements in this Report for more analysis and credit metric information.

By the nature of our status as a REIT, the composition of the loans underlying the participation interests are highly concentrated in real estate.

We continually evaluate and modify our credit policies to address appropriate levels of risk. Measuring and monitoring our credit risk is an ongoing process that tracks delinquencies, collateral values, Fair Isaac Corporation (FICO) scores, economic trends by geographic areas, loan-level risk grading for certain portfolios (typically commercial) and other indications of credit risk. Our credit risk monitoring process is designed to enable early identification of developing risk and to support our determination of an appropriate allowance for credit losses.

 

 

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LOAN PORTFOLIO BY GEOGRAPHY The following table is a summary of the geographical distribution of our loan

portfolio for the top five states by loans outstanding.

 

 

Table 3: Loan Portfolio by Geography

  

 

 
     March 31, 2012  
  

 

 

 
            Real estate      Real estate                
            1-4 family      1-4 family             % of  
            first      junior lien             total  
(in thousands)    Commercial      mortgage      mortgage      Total      loans  

 

 

 

Florida

   $ 319,182         1,020,423         428,488         1,768,093         14 

New Jersey

     219,113         845,061         644,224         1,708,398         14    

Pennsylvania

     54,561         1,012,762         524,177         1,591,500         13    

North Carolina

     221,228         841,830         254,324         1,317,382         10    

Virginia

     210,753         616,615         331,674         1,159,042           

All other states

     220,961         3,787,565         1,086,697         5,095,223         40    

 

 

 

Total loans

   $     1,245,798         8,124,256         3,269,584         12,639,638         100 

 

 

 

COMMERCIAL AND INDUSTRIAL LOANS Table 4 summarizes commercial and industrial loans by industry. We believe the commercial and industrial loans portfolio is well underwritten and is diverse in its risk. Our credit risk management process for this portfolio primarily focuses on a customer’s ability to repay the loan through their cash

flow. A majority of our commercial and industrial loans portfolio is secured by short-term liquid assets, such as accounts receivable, inventory and securities, as well as long-lived assets, such as equipment and other business assets. Generally, the collateral securing this portfolio represents a secondary source of repayment.

 

 

Table 4: Commercial and Industrial Loans by Industry

  

 

 
                     March 31, 2012  
  

 

 

 
            % of  
            total  
(in thousands)    Total      loans  

 

 

 

Management of companies and enterprises

   $ 175,395         62 

Other services (except public administration)

     35,388         12    

Real estate-other (1)

     27,858         10    

Manufacturing

     24,789           

Healthcare and social assistance

     5,729           

Wholesale trade

     5,161           

Finance and insurance

     2,116           

Construction

     1,763           

Other

     3,313           

 

 

 

Total loans

   $ 281,512         100 

 

 

(1) Includes lessors, building operators and real estate agents.

 

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COMMERCIAL REAL ESTATE (CRE) The CRE portfolio consists of both CRE mortgage loans and CRE construction loans. Table 5 summarizes CRE loans by state and property type. The underwriting of CRE loans primarily focuses on cash flows inherent in the creditworthiness of the customer,

in addition to collateral valuations. To identify and manage newly emerging problem CRE loans, we employ a high level of monitoring and regular customer interaction to understand and manage the risks associated with these loans, including regular loan reviews and appraisal updates.

 

 

Table 5: CRE Loans by State and Property Type

  

 

 
     March 31, 2012  
  

 

 

 
                          % of  
           Real estate      Real estate             total  
(in thousands)    mortgage      construction      Total      loans  

 

 
By state:            

Florida

   $ 268,592         13,286         281,878         29 

North Carolina

     203,630         12,479         216,109         22    

New Jersey

     168,686         2,115         170,801         18    

South Carolina

     60,230         117         60,347           

Georgia

     44,590         1,620         46,210           

All other states

     178,737         10,204         188,941         20    

 

 

 

Total loans

  

 

$

 

924,465

 

  

     39,821         964,286         100 

 

 

By property:

           

Office buildings

   $ 241,131         5,182         246,313         26 

Industrial/warehouse

     182,041         -         182,041         19    

Retail (excluding shopping center)

     141,991         2,200         144,191         15    

Shopping center

     86,218         -         86,218           

Hotel/motel

     82,159         153         82,312           

Real estate - other

     68,590         6,699         75,289           

Apartments

     57,104         713         57,817           

Institutional

     50,019         -         50,019           

Land (excluding 1-4 family)

     8,974         19,388         28,362           

Other

     6,238         5,486         11,724           

 

 

 

Total loans

  

 

$

 

924,465

 

  

     39,821         964,286         100 

 

 

 

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REAL ESTATE 1-4 FAMILY MORTGAGE LOANS The concentrations of real estate 1-4 family mortgages by state and the related combined loan–to–value (CLTV) ratio are presented in Table 6. Our underwriting and periodic review of loans collateralized by residential real property includes appraisals or estimates from automated valuation models (AVMs). Additional information about AVMs and our policy for their use can be found in the “Risk Management – Credit Risk Management” section in our 2011 Form 10-K.

We continue to modify real estate 1-4 family mortgage loans to assist homeowners and other borrowers in the current difficult economic cycle. For more information on our participation in the U.S. Treasury’s Making Home Affordable (MHA) programs, see the “Risk Management – Credit Risk Management” section in our 2011 Form 10-K.

We continuously monitor changes in real estate values and underlying economic or market conditions for all geographic areas of our real estate 1-4 family mortgage portfolio as part of our credit risk management process.

The Bank and/or other Wells Fargo affiliates act as servicer for our loan portfolio, including our consumer real estate loans.

The Board of Governors of the Federal Reserve System (FRB) and the Office of the Comptroller of the Currency (OCC) made public April 13, 2011, consent orders that require Wells Fargo and the Bank to correct deficiencies in residential mortgage loan servicing and foreclosure practices that were identified by the FRB and OCC in their

review of foreclosure practices at large mortgage servicers conducted in fourth quarter 2010.

As announced in February 2012, Wells Fargo and the Bank reached a settlement regarding their mortgage servicing and foreclosure practices with certain federal and state government entities, which became effective on April 5, 2012, where they committed to take certain actions, including the payment of fines, forgive principal for certain borrowers and provide additional relief to certain borrowers.

The financial impact of the settlement to Wachovia Funding is not expected to be material because any related costs are already appropriately covered in our allowance for credit losses and in the nonaccretable difference relating to PCI loans or we believe the prospective interest income impact of a rate reduction will not be material for loans eligible for the rate refinancing program. In addition, our loan participation and servicing agreements with the Bank include covenants by the Bank to hold us harmless from any claims, causes of action, suits, damages and costs and expenses (including reasonable attorneys’ fees) arising from any unlawful act or omission occurring intentionally or unintentionally in connection with the loan products, loan applications, closings, dispositions, and servicing arising under or with respect to any of the loan participations in our portfolio. See the “Risk Management – Credit Risk Management” section in our 2011 Form 10-K for more details.

 

 

Table 6: Real Estate 1-4 Family Mortgage Loans by State and CLTV

  

 

 
                     March  31, 2012  
     Real estate      Current  
     1-4 family      CLTV  
(in thousands)    mortgage      ratio (1)  

 

 

 

Pennsylvania

   $ 1,536,939         68 

New Jersey

     1,489,285         71    

Florida

     1,448,911         87    

North Carolina

     1,096,154         72    

Virginia

     948,289         72    

All other states

     4,874,262         72    

 

    

 

Total loans

   $ 11,393,840      

 

 

 

(1)  Collateral values are generally determined using AVMs and are updated quarterly. AVMs are computer-based tools used to estimate market values of homes based on processing large volumes of market data including market comparables and price trends for local market areas.

 

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HOME EQUITY PORTFOLIOS Our home equity portfolio includes real estate 1-4 family junior lien mortgages secured by real estate. The majority of our junior lien loans are amortizing payment loans with fixed interest rates and repayment periods between 5 to 30 years. Junior lien loans with balloon payments at the end of the repayment term represent a small portion of our junior lien loans. We frequently monitor the credit performance of our junior lien mortgage portfolio for trends and factors that influence the frequency and severity of loss.

      In first quarter 2012, in accordance with Interagency Supervisory Guidance on Allowance for Loan and Lease Losses Estimation Practices for Loans and Lines of Credit Secured by Junior Liens on 1-4 Family Residential

Properties issued January 31, 2012 (Interagency Guidance), a junior lien is now reported as a nonaccrual loan if the related first lien is 120 days past due or is in the process of foreclosure. This action had minimal financial impact as the expected loss content of these loans was already considered in the loan loss allowance. See the “Risk Management—Credit Risk Management—Nonperforming Assets” section in this report for more information.

      Table 7 summarizes quarterly delinquency and loss rates by state for our home equity portfolio, which reflected the largest portion of our credit losses in first quarter 2012 and 2011.

 

 

Table 7: Home Equity Portfolio (1)

  

 

                   % of loans      Loss rate  
                   two payments      (annualized)  
                 Outstanding balance                  or more past  due                  Quarter ended  
    

 

Mar. 31,

     Dec. 31,          Mar. 31,     Dec. 31,          Mar. 31,      Dec. 31,  
(in thousands)    2012      2011      2012     2011      2012      2011  

 

 

New Jersey

   $ 641,030         668,234         5.14      5.69         3.67         4.01   

Pennsylvania

     521,614         534,996         3.56         3.90         1.36         2.38   

Florida

     426,225         453,952         4.53         5.66         7.03         7.52   

Virginia

     329,987         332,236         2.90         3.12         2.50         2.05   

North Carolina

     252,198         257,958         3.92         3.83         3.60         2.43   

Other

     1,081,706         985,059         3.71         4.86         4.27         3.84   

 

            

 

Total

   $ 3,252,760         3,232,435         4.01         4.73         3.82         3.86   

 

            

 

 
(1)  Consists of real estate 1-4 family junior lien mortgages, excluding PCI loans of $16,824 at March 31, 2012 and $17,447 at December 31, 2011.

 

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NONPERFORMING ASSETS (NONACCRUAL LOANS AND FORECLOSED ASSETS) We generally place loans on nonaccrual status when:

 

the full and timely collection of interest or principal becomes uncertain (generally based on an assessment of the borrower’s financial condition and the adequacy of collateral, if any);

 

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;

 

part of the principal balance has been charged off and no restructuring has occurred; or

 

effective first quarter 2012, for junior lien mortgages, we have evidence that the related first lien mortgage may be 120 days past due or in the process of foreclosure regardless of the junior lien delinquency status.

Table 8 provides the comparative data for nonaccrual loans and foreclosed assets. Foreclosed assets decreased to $6.8 million at March 31, 2012 from $6.9 million at December 31, 2011.

 

 

Table 8: Nonperforming Assets (Nonaccrual Loans and Foreclosed Assets)

  

 

         Mar. 31,     Dec. 31,      Sept. 30,      June 30,      Mar. 31,  
(in thousands)        2012     2011      2011      2011      2011  

 

 

Nonaccrual loans:    

               

Commercial:

               

Commercial and industrial

     $                        900         901    

Real estate mortgage

       18,623         21,132         25,834         21,799         22,454    

Real estate construction

       180         251         263         563         442    

 

 

 

Total commercial

           18,803         21,383         26,097         23,262         23,797    

 

 

Consumer:

               

Real estate 1-4 family first mortgage

       235,737         228,363         212,626         231,414         222,843    

Real estate 1-4 family junior lien mortgage (1)

       152,824         99,347         102,763         108,520         107,812    

 

 

Total consumer

           388,561         327,710         315,389         339,934         330,655    

 

 

Total nonaccrual loans

           407,364         349,093         341,486         363,196         354,452    

 

 

Foreclosed assets

           6,769         6,926         7,418         3,527         8,774    

 

 

Total nonperforming assets

     $       414,133         356,019         348,904         366,723         363,226    

 

 

As a percentage of total loans

           3.28      2.84         2.73         2.71         2.54    

 

 

 

(1)  Includes $55.2 million at March 31, 2012, resulting from implementation of the Interagency Guidance issued on January 31, 2012. This guidance accelerated the timing of placing these loans on nonaccrual to coincide with the timing of placing the related real estate 1-4 family first mortgage loans on nonaccrual.

 

Table 9: Analysis of Changes in Nonaccrual Loans

  

 

     Quarter ended  
             Mar. 31,     Dec. 31,     Sept. 30,     June 30,     Mar. 31,  
(in thousands)    2012     2011     2011     2011     2011  

 

 

Commercial nonaccrual loans    

          

Balance, beginning of quarter

   $           21,383        26,097        23,262        23,797        24,311   

Inflows

     1,871        1,469        3,268        888        1,409   

Outflows

     (4,451     (6,183     (433     (1,423     (1,923

 

 

 

Balance, end of quarter

     18,803        21,383        26,097        23,262        23,797   

 

 

 

Consumer nonaccrual loans

          

Balance, beginning of quarter

     327,710        315,389        339,934        330,655        342,515   

Inflows (1)

     154,618        109,847        87,055        96,860        102,183   

Outflows:

          

Returned to accruing

     (42,556     (51,317     (67,175     (32,658     (61,060

Foreclosures

     (4,897     (1,946     (2,233     (5,984     (4,072

Charge-offs

     (42,903     (37,660     (29,594     (31,697     (41,226

Payment, sales and other

     (3,411     (6,603     (12,598     (17,242     (7,685

 

 

Total outflows

     (93,767     (97,526     (111,600     (87,581     (114,043

 

 

Balance, end of quarter

          388,561        327,710        315,389        339,934        330,655   

 

 

Total nonaccrual loans    

   $         407,364        349,093        341,486        363,196        354,452   

 

 

 

(1)  March 31, 2012 includes $55.2 million of junior liens classified as nonaccrual status as a result of implementing Interagency Guidance issued January 31, 2012.

 

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Typically, changes to nonaccrual loans period-over-period represent inflows for loans that reach a specified past due status, offset by reductions for loans that are charged off, sold, transferred to foreclosed assets, or are no longer classified as nonaccrual as a result of continued performance and an improvement in the borrower’s financial condition and loan repayment capabilities.

Nonaccrual loans increased to $407.4 million at March 31, 2012, from $349.1 million at December 31, 2011. As noted previously, the first quarter 2012 increase primarily related to classification of $55.2 million of junior liens to nonaccrual upon implementation of the Interagency Guidance.

 

 

TROUBLED DEBT RESTRUCTURINGS (TDRs)

 

 

Table 10: Troubled Debt Restructurings (TDRs) (1)

  

 

             Mar. 31,      Dec. 31,      Sept. 30,      June 30,      Mar. 31,  
(in thousands)    2012      2011      2011      2011      2011  

 

 

Commercial TDRs:

              

Commercial and industrial

   $ -         -         -         -           

Real estate mortgage

     2,664         2,470         2,582         2,426         2,439    

Real estate construction

     -         -         -         -           

 

 

Total commercial TDRs

         2,664         2,470         2,582         2,426         2,439    

 

 

Consumer TDRs:

              

Real estate 1-4 family first mortgage

     198,756         191,773         179,694         162,459         133,355    

Real estate 1-4 family junior lien mortgage

     110,441         111,463         109,645         103,765         92,213    

Trial modifications (1)

     23,681         21,369         20,373         28,259         27,488    

 

 

Total consumer TDRs

          332,878         324,605         309,712         294,483         253,056    

 

 

Total TDRs

   $  335,542         327,075         312,294         296,909         255,495    

 

 

TDRs on nonaccrual status    

   $  97,942         85,733         87,368         106,155         78,139    

TDRs on accrual status

          237,600         241,342         224,926         190,754         177,356    

 

 

Total TDRs

   $  335,542         327,075         312,294         296,909         255,495    

 

 

 

(1)  Based on clarifying guidance from the SEC received in December 2011, we classify trial modifications as TDRs at the beginning of the trial period. For many of our consumer real estate modification programs, we may require a borrower to make trial payments generally for a period of three to four months. Prior to the SEC clarification, we classified trial modifications as TDRs once a borrower successfully completed the trial period in accordance with the terms.

 

Table 11: Analysis of Changes in TDRs

  

 

     Quarter ended  
             Mar. 31,     Dec. 31,     Sept. 30,     June 30,     Mar. 31,  
(in thousands)    2012     2011     2011     2011     2011  

 

 

Commercial TDRs:    

          

Balance, beginning of quarter

   $ 2,470        2,582        2,426        2,439        2,454   

Inflows

     1,377        -        156        -        2   

Outflows

     (1,183     (112     -        (13     (17

 

 

Balance, end of quarter    

     2,664        2,470        2,582        2,426        2,439   

 

 

Consumer TDRs:    

          

Balance, beginning of quarter

     324,605        309,712        294,483        253,056        220,468   

Inflows

     19,648        27,840        42,219        52,207        44,766   

Outflows:

          

Charge-offs

     (7,223     (6,618     (5,621     (3,020     (3,442

Foreclosures

     (141     -        (36     (230     (26

Payments, sales and other (1)

     (6,323     (7,325     (13,447     (8,301     (11,218

Net change in trial modifications (2)

     2,312        996        (7,886     771        2,508   

 

 

Total outflows

     (11,375     (12,947     (26,990     (10,780     (12,178

 

 

Balance, end of quarter    

     332,878        324,605        309,712        294,483        253,056   

 

 

Total TDRs    

   $ 335,542        327,075        312,294        296,909        255,495   

 

 

 

(1)  Other outflows include normal amortization/accretion of loan basis adjustments.
(2)  Net change in trial modifications includes: inflows of new TDRs entering the trial payment period, net of outflows for modifications that either (i) successfully perform and enter into a permanent modification or (ii) do not successfully perform according to the terms of the trial period plan and are subsequently charged-off, foreclosed upon or otherwise resolved. Our recent experience is that a majority of the mortgages that enter a trial payment period program are successful in completing the program requirements.

 

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Table 10 provides information regarding the recorded investment of loans modified in TDRs. Table 11 provides an analysis of the changes in TDRs. The allowance for loan losses for TDRs was $101.6 million and $104.3 million at March 31, 2012 and December 31, 2011, respectively. See Note 2 (Loans and Allowance for Credit Losses) to Financial Statements in this Report for more information.

We do not forgive principal for a majority of our TDRs, but in those situations where principal is forgiven, the entire amount of such principal forgiveness is immediately charged

off to the extent not done so prior to the modification. We sometimes delay the timing on the repayment of a portion of principal (principal forbearance) and charge off the amount of forbearance if that amount is not considered fully collectible.

 

 

 

 

LOANS 90 DAYS OR MORE PAST DUE AND STILL ACCRUING Certain loans 90 days or more past due as to interest or principal are still accruing, because they are (1) well-secured and in the process of collection or (2) real estate 1-4 family mortgage loans exempt under regulatory rules from being classified as nonaccrual until later delinquency, usually 120 days past due. PCI loans of $7.1 million at March 31, 2012, and $7.6 million at December 31, 2011, are excluded from this disclosure even though they are 90 days or more contractually past due. These PCI loans are considered to be accruing due to the existence of the accretable yield and not

based on consideration given to contractual interest payments.

Loans 90 days or more past due and still accruing at March 31, 2012, were down $16.3 million, or 43%, from December 31, 2011, of which $2.7 million of this decline resulted from implementation of the Interagency Guidance. The additional decline is due to loss mitigation activities including modifications, charge-offs, seasonally lower early stage delinquency levels, and credit stabilization. Table 12 reflects non-PCI loans 90 days or more past due and still accruing.

 

 

Table 12: Loans 90 Days or More Past Due and Still Accruing

 

(in thousands)

       Mar.  31,      Dec. 31,      Sept. 30,      June 30,      Mar. 31,  
   2012      2011      2011      2011      2011  

Commercial:    

              

Commercial and industrial

   $ -         -         -         2         6   

Real estate mortgage

     -         1,596         1,483         3,418         -   

Real estate construction

     -         -         -         -         -   

Total commercial

         -         1,596         1,483         3,420         6   

Consumer:

              

Real estate 1-4 family first mortgage

     16,211         21,008         20,519         19,958         13,476   

Real estate 1-4 family junior lien mortgage (1)

     5,560         15,492         13,688         10,449         13,700   

Total consumer

         21,771         36,500         34,207         30,407         27,176   

Total

   $  21,771         38,096         35,690         33,827         27,182   

 

(1)  During first quarter 2012, $2.7 million of 1-4 family junior lien mortgages were transferred to nonaccrual upon implementation of the Interagency Guidance issued on January 31, 2012.

 

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NET CHARGE-OFFS

Table 13: Net Charge-offs

 

 
     Quarter ended  
                          March 31,
2012
                         December 31,
2011
                    September  30,
2011
                June 30,
2011
                March 31,
2011
 
($ in thousands)   

Net loan

charge-

offs

    

% of

avg.

loans (1)

   

Net loan

charge-

offs

    

% of

avg.

loans (1)

   

Net loan

charge-

offs

    

% of

avg.

loans (1)

   

Net loan

charge-

offs

    

% of

avg.

loans (1)

   

Net loan

charge-

offs

   

% of

avg.

loans (1)

 

 

 

Total commercial    

   $ 248         0.08    $ 586         0.17    $ 85         0.02    $ 116         0.03    $ (42     (0.01 ) % 

Consumer:

                        

Real estate 1-4 family first mortgage

     22,865         1.18        17,959         0.92        16,324         0.79         19,272         0.89        22,969        1.00   

Real estate 1-4 family junior lien mortgage

     30,060         3.80        32,162         3.85        30,784         3.49         32,108         3.49        42,395        4.38   

Total consumer    

     52,925         1.94         50,121         1.79         47,108         1.60         51,380         1.66         65,364        1.99    

Total    

   $ 53,173         1.74    $     50,707         1.61    $   47,193         1.42    $ 51,496         1.49    $ 65,322        1.78 

 

 

(1)  Quarterly net charge-offs (net recoveries) as a percentage of average loans are annualized.

 

Table 13 presents net charge-offs for the current and previous four quarters. Net charge-offs in first quarter 2012 were $53.2 million (1.74% of average total loans outstanding, annualized) compared with $65.3 million (1.78%) in first quarter 2011. Total net charge-offs decreased in first quarter 2012 in part due to lower average loan balances and as a result of continued modest improvement in economic conditions and aggressive loss mitigation activities aimed at working with our customers through their financial challenges. The majority of losses were in consumer real estate.

Net charge-offs in the 1-4 family first mortgage portfolio totaled $22.9 million in first quarter 2012 compared with $23.0 million in first quarter 2011.

Net charge-offs in the real estate 1-4 family junior lien portfolio were $30.1 million in first quarter 2012 reduced from $42.4 million in first quarter 2011 due to delinquency improvement within the portfolio. More information about the home equity portfolio is available in Table 7 in this Report.

Commercial and industrial and CRE net charge-offs in first quarter 2012 and 2011 were not significant. Although economic stress and decreased CRE values have resulted in the deterioration of our commercial and industrial and CRE credit portfolios, there have been relatively small losses. Due to the larger dollar amounts associated with individual commercial and industrial and CRE loans, loss recognition tends to be irregular and exhibits more variation than consumer loan portfolios.

 

 

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Table of Contents

ALLOWANCE FOR CREDIT LOSSES The allowance for credit losses, which consists of the allowance for loan losses and the allowance for unfunded credit commitments, is management’s estimate of credit losses inherent in the loan portfolio and unfunded credit commitments at the balance sheet date. The detail of the changes in the allowance for credit losses by portfolio segment (including charge-offs and recoveries by loan class) is in Note 2 (Loans and Allowance for Credit Losses) to Financial Statements in this Report.

 We employ a disciplined process and methodology to establish our allowance for credit losses each quarter. This process takes into consideration many factors, including historical and forecasted loss trends, loan-level credit quality ratings and loan grade-specific loss factors. The process involves subjective as well as complex judgments. In addition, we review a variety of credit metrics and trends. However, these trends do not solely determine the appropriate level of the allowance as we use several analytical tools for such evaluation. For additional information on our allowance for credit losses, see the “Critical Accounting Policies – Allowance for Credit Losses” section and Note 2 (Loans and Allowance for Credit Losses) to Financial Statements in our 2011 Form 10-K.

 At March 31, 2012, the allowance for credit losses totaled $310.1 million, compared with $313.9 million, at December 31, 2011. We believe the allowance for credit losses of $310.1 million at March 31, 2012, was appropriate to cover credit losses inherent in the loan portfolio, including unfunded credit commitments. The allowance for credit losses is subject to change and considers existing factors at the time, including economic or market conditions and ongoing internal and external examination processes.

 The ratio of the allowance for credit losses to total nonaccrual loans may fluctuate from period to period due to such factors as the mix of loan types in the portfolio, the amount of nonaccrual loans that have been written down to current collateral value, borrower credit strength and the value and marketability of collateral.

 Total provision for credit losses was $51.3 million in first quarter 2012 and $52.5 million in first quarter 2011. The first quarter 2012 provision was $1.9 million less than net charge-offs. In first quarter 2011, the provision was lower than net charge-offs by $12.9 million. Primary drivers of the first quarter 2012 and 2011 provision reductions were decreased net charge-offs and improvement in the credit quality of the portfolios and related loss estimates as seen in lower delinquent loan levels.

 In determining the appropriate allowance attributable to our residential real estate portfolios, our process considers the associated credit cost, including re-defaults of modified loans and projected loss severity for loan modifications that occur or are probable to occur. In addition, our process incorporates the estimated allowance associated with recent events including the Wells Fargo/Bank settlement regarding mortgage servicing and foreclosure practices and high risk portfolios defined in the Interagency Guidance.

 Changes in the allowance reflect changes in statistically derived loss estimates, historical loss experience, current trends in borrower risk and/or general economic activity on portfolio performance, and management’s estimate for imprecision and uncertainty.

 Table 14 presents an analysis of the allowance for credit losses for the last five quarters.

 

 

Table 14: Allowance for Credit Losses

(in thousands)   

 

Mar. 31,

2012

   

Dec. 31,

2011

    

Sept. 30,

2011

    

June 30,

2011

    

Mar. 31,

2011

 

 

Components:

                                           

Allowance for loan losses

   $     309,913        313,762         292,746         311,495         389,310   

Allowance for unfunded credit commitments

     200        166         167         219         308   

Allowance for credit losses    

   $ 310,113        313,928         292,913         311,714         389,618   

Allowance for loan losses as a percentage of total loans

     2.45      2.50         2.29         2.30         2.73   

Allowance for loan losses as a percentage of annualized net charge-offs

     144.91        155.97         156.35         150.81         146.96   

Allowance for credit losses as a percentage of total loans

     2.45        2.50         2.30         2.30         2.73   

Allowance for credit losses as a percentage of total nonaccrual loans

     76.13        89.93         85.78         85.83         109.92   

 

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Asset/Liability Management

Asset/liability management involves the evaluation, monitoring and management of interest rate risk, market risk and liquidity and funding.

INTEREST RATE RISK Interest rate risk is the sensitivity of earnings to changes in interest rates. Approximately 17% of our loan portfolio consisted of variable rate loans at March 31, 2012. In a declining rate environment, we may experience a reduction in interest income on our loan portfolio and a corresponding decrease in funds available to be distributed to our shareholders. The reduction in interest income may result from downward adjustment of the indices upon which the interest rates on loans are based and from prepayments of loans with fixed interest rates, resulting in reinvestment of the proceeds in lower yielding assets.

 At March 31, 2012, approximately 83% of the balance of our loans had fixed interest rates. Such loans tend to increase our interest rate risk. We monitor the rate sensitivity of assets acquired. Our methods for evaluating interest rate risk include an analysis of interest-rate sensitivity “gap,” which is defined as the difference between interest-earning assets and interest-bearing liabilities maturing or repricing within a given time period. A gap is considered positive when the amount of interest rate-sensitive assets exceeds the amount of interest rate-sensitive liabilities. A gap is considered negative when the amount of interest rate-sensitive liabilities exceeds interest rate-sensitive assets.

 During a period of rising interest rates, a negative gap would tend to adversely affect net interest income, while a positive gap would tend to result in an increase in net interest income. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income, while a positive gap would tend to affect net interest income adversely. Because different types of assets and liabilities with the same or similar maturities may react differently to changes in overall market rates or conditions, changes in interest rates may affect net interest income positively or negatively even if an institution is perfectly matched in each maturity category.

 At March 31, 2012, $3.3 billion, or 24% of our assets, had variable interest rates and could be expected to reprice with changes in interest rates. At March 31, 2012, our liabilities were $227.0 million, or 2% of our assets, while stockholders’ equity was $13.5 billion, or 98% of our assets. This positive gap between our assets and liabilities indicates that an increase in interest rates would result in an increase in net interest income and a decrease in interest rates would result in a decrease in net interest income.

 All of our derivatives are economic hedges and none are treated as accounting hedges. In addition, all our derivatives (currently consisting of interest rate swaps) are recorded at fair value in the balance sheet. When we have more than one transaction with a counterparty and there is a legally enforceable master netting agreement between the parties, the net of the gain and loss positions are recorded as an

asset or a liability in our consolidated balance sheet. Realized and unrealized gains and losses are recorded as a net gain or loss on interest rate swaps in our consolidated statement of income.

 In 2001, the Bank contributed receive-fixed interest rate swaps with a notional amount of $4.25 billion and a fair value of $673.0 million to us in exchange for common stock. The unaffiliated counterparty to the receive-fixed interest rate swaps provided cash collateral to us. We pay interest to the counterparty on the collateral at a short-term interest rate. Shortly after the contribution of the receive-fixed interest rate swaps, we entered into pay-fixed interest rate swaps with a notional amount of $4.25 billion that serve as an economic hedge of the contributed swaps. All interest rate swaps are transacted with the same unaffiliated third party.

 See Note 3 (Derivatives) to Financial Statements in this Report for more details.

MARKET RISK Market risk is the risk of loss from adverse changes in market prices and interest rates. Market risk arises primarily from interest rate risk inherent in lending, investment in derivative financial instruments and borrowing activities.

 Due to the difference in fixed rates in our interest rate swaps, volatility is expected given certain interest rate fluctuations. If market rates were to decrease 100 basis points or 200 basis points, we would recognize short-term net gains on our interest rate swaps of $79 thousand or $157 thousand, respectively. If interest rates were to increase 100 basis points or 200 basis points, we would recognize short-term net losses on our interest rate swaps of $78 thousand or $156 thousand, respectively. These short-term fluctuations will eventually offset over the life of the interest rate swaps when held to maturity, with no change in cash flow occurring for the net positions. The changes in value of the net swap positions were calculated under the assumption there was a parallel shift in the LIBOR curve using 100 basis point and 200 basis point shifts, respectively.

LIQUIDITY AND FUNDING The objective of effective liquidity management is to ensure that we can meet customer loan requests and other cash commitments efficiently under both normal operating conditions and under unpredictable circumstances of industry or market stress. To achieve this objective, Wells Fargo’s Corporate Asset/Liability Management Committee 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.

 Proceeds received from pay-downs of loans are typically sufficient to fund existing lending commitments and loan purchases. Depending upon the timing of the loan purchases, we may draw on the line of credit we have with the Bank as a short-term liquidity source. Generally, we repay these borrowings within several months as we receive

 

 

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cash on loan pay-downs from our loan portfolio. At March 31, 2012, there were no borrowings outstanding on our line of credit with the Bank.

 Wachovia Funding’s primary liquidity needs are to pay operating expenses, fund our lending commitments, purchase loans as the underlying loans mature or repay, and pay dividends. Operating expenses and dividends are expected to be funded through cash generated by operations or paid-in capital, while funding commitments and the acquisition of additional participation interests in loans are intended to be funded with the proceeds obtained from repayment of principal balances by individual borrowers. In first quarter 2012, we purchased $943.5 million of loan participations from the Bank. If in future periods we do not reinvest loan pay-downs at anticipated levels, management may request our board of directors to consider an additional return of capital to holders of our common stock. We expect to distribute annually an aggregate amount of dividends with respect to outstanding capital stock equal to approximately 100 percent of our REIT taxable income for federal tax purposes. Such distributions may in some periods exceed net income.

 To the extent that we determine that additional funding is required, we could issue additional common or preferred stock, subject to any pre-approval rights of our shareholders or raise funds through debt financings, retention of cash flows or a combination of these methods. We do not have and do not anticipate having any material capital expenditures in the foreseeable future. We believe our existing sources of liquidity are sufficient to meet our funding needs. However, any cash flow retention must be consistent with the provisions of the Investment Company Act and the Code which requires the distribution by a REIT of at least 90% of its REIT taxable income, excluding capital gains, and must take into account taxes that would be imposed on undistributed income.

 Except in certain circumstances, our Series A preferred securities may not be redeemed prior to December 31, 2022. Prior to that date, among other things, if regulators adopt capital standards that do not permit Wells Fargo or the Bank to treat our Series A preferred securities as Tier 1 capital, we may determine to redeem the Series A preferred securities, as provided in our certificate of incorporation. Regulatory authorities have yet to propose final regulations to implement certain capital standards required in the Dodd-Frank Act. It is possible that such capital standards, when proposed and adopted, will affect Wells Fargo’s or the Bank’s ability to treat our Series A preferred securities as Tier 1 capital. We will continue to monitor the proposed capital standards and whether such capital standards would result in our determination that a Regulatory Capital Event, as defined in our certificate of incorporation, has occurred and therefore cause the Series A preferred securities to become redeemable under their terms. Although any such redemption must be in whole for a redemption price of $25.00 per Series A security, plus all authorized, declared but unpaid dividends to the date of redemption, such event

may have an adverse effect on the trading price for the Series A preferred securities.

 At March 31, 2012, our liabilities principally consist of dividends payable, deferred income tax liabilities and other liabilities. Our certificate of incorporation does not contain any limitation on the amount or percentage of debt, funded or otherwise, we may incur, except the incurrence of debt for borrowed money or our guarantee of debt for borrowed money in excess of amounts borrowed or guaranteed. However, as part of issuing our Series A preferred securities, we have a covenant in which we agree not to incur indebtedness over 20% of our stockholders’ equity unless approved by two-thirds of the Series A preferred securities, voting as a separate class.

 

 

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Critical Accounting Policy

 

 

Our significant accounting policies (see Note 1 (Summary of Significant Accounting Policies) to Financial Statements in our 2011 Form 10-K) are fundamental to understanding our results of operations and financial condition because they require that we use estimates and assumptions that may affect the value of our assets or liabilities and financial results. One of these policies is critical because it requires 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. We have identified the allowance for credit losses policy as being particularly sensitive in terms of judgments and the extent to which estimates are used.

 Management has reviewed and approved this critical accounting policy and has discussed this policy with the Audit Committee of Wachovia Funding’s board of directors. This policy is described in the “Critical Accounting Policy” section in our 2011 Form 10-K.

 

 

Current Accounting Developments

 

 

There are no current accounting pronouncements that have been issued by the Financial Accounting Standards Board (FASB) that would impact Wachovia Funding for this quarter.

 

 

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Forward-Looking Statements

 

 

This Report contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by words such as “anticipates,” “intends,” “plans,” “seeks,” “believes,” “estimates,” “expects,” “target”, “projects,” “outlook,” “forecast,” “will,” “may,” “could,” “should,” “can” and similar references to future periods. Examples of forward-looking statements include, but are not limited to, statements we make about: future results of Wachovia Funding; expectations for consumer and commercial credit losses, life-of-loan losses, and the sufficiency of our credit loss allowance to cover future credit losses; possible capital distributions; the expected outcome and impact of legal, regulatory and legislative developments, including regulatory capital standards and the effects to Wachovia Funding of the agreement in principle between Wells Fargo, the Bank and certain regulatory authorities related to mortgage servicing and foreclosure practices; and Wachovia Funding’s plans, objectives and strategies.

 Forward-looking statements are based on our current expectations and assumptions regarding our business, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. Our actual results may differ materially from those contemplated by the forward-looking statements. We caution you, therefore, against relying on any of these forward-looking statements. They are neither statements of historical fact nor guarantees or assurances of future performance. While there is no assurance that any list of risks and uncertainties or risk factors is complete, important factors that could cause actual results to differ materially from those in the forward-looking statements include the following, without limitation:

 

   

the effect of political and economic conditions and geopolitical events;

 

   

economic conditions that affect the general economy, housing prices, the job market, consumer confidence and spending habits, including our borrowers repayment of our loan participations;

 

   

the level and volatility of the capital markets, interest rates, currency values and other market indices that affect the value of our assets and liabilities;

 

   

the availability and cost of both credit and capital as well as the credit ratings assigned to our debt instruments;

 

   

investor sentiment and confidence in the financial markets;

 

   

our reputation;

 

   

the impact of current, pending and future legislation, regulation and legal actions, including capital standards applicable to the Bank or Wells Fargo;

 

   

changes in accounting standards, rules and interpretations;

 

   

mergers and acquisitions, and our ability to integrate them;

 

various monetary and fiscal policies and regulations of the U.S. and foreign governments;

 

 

a failure in or breach of our, the Bank’s or Wells Fargo’s operational or security systems or infrastructure, or those of third party vendors and other security providers, including as a result of cyber attacks;

 

 

financial services reform and other current, pending or future legislation or regulation that could have a negative effect on our revenue and businesses, including the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) and legislation; and

 

 

the other factors described in “Risk Factors” in this Report.

 In addition to the above factors, we also caution that there is no assurance that our allowance for credit losses will be adequate to cover future credit losses, especially if credit markets, housing prices and unemployment do not continue to stabilize or improve. Increases in loan charge-offs or in the allowance for credit losses and related provision expense could materially adversely affect our financial results and condition.

 Any forward-looking statement made by us in this Report speaks only as of the date on which it is made. Factors or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.

 

 

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Risk Factors

 

 

An investment in Wachovia Funding involves risk, including the possibility that the value of the investment could fall substantially and that dividends or other distributions on the investment could be reduced or eliminated. We discuss previously under “Forward-Looking Statements” and elsewhere in this Report, as well as in other documents we file with the SEC, risk factors that could adversely affect our financial results and condition and the value of, and return on, an investment in Wachovia Funding. We refer you to the Financial Review section and Financial Statements (and related Notes) in this Report for more information about credit, interest rate, market, and litigation risks and to the “Risk Factors” sections in our 2011 Form 10-K for more information about risks. Any factor in this Report or in our 2011 Form 10-K could by itself, or together with other factors, adversely affect our financial results and condition, or the value of an investment in Wachovia Funding. There are factors elsewhere in this Report that could adversely affect our financial results and condition.

 

 

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Controls and Procedures

Disclosure Controls and Procedures

 

As required by SEC rules, Wachovia Funding’s management evaluated the effectiveness, as of March 31, 2012, of disclosure controls and procedures. Wachovia Funding’s chief executive officer and chief financial officer participated in the evaluation. Based on this evaluation, the chief executive officer and chief financial officer concluded that Wachovia Funding’s disclosure controls and procedures were effective as of March 31, 2012.

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, Wachovia Funding’s principal executive and principal financial officers and effected by Wachovia Funding’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 Wachovia Funding;

   

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 Wachovia Funding are being made only in accordance with authorizations of management and directors of Wachovia Funding; and

   

provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of Wachovia Funding’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 first quarter 2012 that has materially affected, or is reasonably likely to materially affect, Wachovia Funding’s internal control over financial reporting.

 

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Financial Statements

Wachovia Preferred Funding Corp. and Subsidiaries

Consolidated Statement of Income (Unaudited)        
                 Quarter ended March  31,  

(in thousands, except per share amounts)

  

 

 

 

2012

 

  

  

 

 

 

2011

 

  

 

 

 

Interest income

  

 

$

 

216,916

 

  

  

 

 

 

280,340

 

  

Interest expense      -         -   

 

 

 

Net interest income

     216,916         280,340   

Provision for credit losses

     51,259         52,466   

 

 

 

Net interest income after provision for credit losses

     165,657         227,874   

 

 

 

Noninterest income

     

Gain on interest rate swaps

     56         110   

Gain on loan sales to affiliate

     -         113   

Other

     304         237   

 

 

 

Total noninterest income

     360         460   

 

 

 

Noninterest expense

     

Loan servicing costs

     10,804         12,983   

Management fees

     1,932         1,150   

Foreclosed assets

     2,340         2,546   

Other

     837         696   

 

 

 

Total noninterest expense

     15,913         17,375   

 

 

 

Income before income tax expense

  

 

 

 

150,104

 

  

  

 

 

 

210,959

 

  

Income tax expense

     89         92   

 

 

 

Net income

  

 

 

 

150,015

 

  

  

 

 

 

210,867

 

  

Dividends on preferred stock

     49,586         45,946   

 

 

 

Net income applicable to common stock

   $ 100,429         164,921   

 

 

 

Per common share information

     

Earnings per common share

   $ 1.00         1.65   

Diluted earnings per common share

     1.00         1.65   

Dividends declared per common share

   $ 1.50         2.24   

Average common shares outstanding

     99,999.9         99,999.9   

Diluted average common shares outstanding

     99,999.9         99,999.9   
     

 

 

The accompanying notes are an integral part of these statements.

 

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Financial Statements

Wachovia Preferred Funding Corp. and Subsidiaries

Consolidated Balance Sheet (Unaudited)                 

(in thousands, except shares)

  

 

 
 

 

March 31,
2012

 

  
  

 

 

 
 

 

December 31,
2011

 

  
  

 

Assets

    

Cash and cash equivalents

   $ 1,235,466        1,186,165   

Loans, net of unearned income

     12,639,638        12,543,776   

Allowance for loan losses

     (309,913     (313,762

 

Net loans

     12,329,725        12,230,014   

 

Interest rate swaps, net

  

 

 

 

1,028

 

  

 

 

 

 

963

 

  

Accounts receivable - affiliates, net

     48,470        64,235   

Other assets

     65,145        53,018   

 

Total assets

   $ 13,679,834        13,534,395   

 

Liabilities

    

 

Dividends payable - affiliates

   $ 186,062        -   

Deferred income taxes

     4,448        9,327   

Other liabilities

     36,452        22,625   

 

Total liabilities

     226,962        31,952   

 

Stockholders’ Equity

    

Preferred stock

     743        743   

Common stock - $0.01 par value, authorized 100,000,000 shares;
issued and outstanding 99,999,900 shares

     1,000        1,000   

Additional paid-in capital

     14,026,608        14,026,608   

Retained earnings (deficit)

     (575,479     (525,908

 

Total stockholders’ equity

  

 

 

 

13,452,872

 

  

 

 

 

 

13,502,443

 

  

 

Total liabilities and stockholders’ equity

  

 

$

 

13,679,834

 

  

 

 

 

 

13,534,395

 

  

The accompanying notes are an integral part of these statements.

 

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Financial Statements

Wachovia Preferred Funding Corp. and Subsidiaries

Consolidated Statement of Changes in Stockholders’ Equity (Unaudited)   

(in thousands, except per share data)

    
 
Preferred
stock
  
  
    
 
Common
stock
  
  
  

 

 
 
 

 

Additional
paid-in
capital

 

  
  
  

 

 

 
 
 

 

Retained
earnings
(deficit)

 

  
  
  

 

 

 
 
 

 

Total
stockholders’
equity

 

  
  
  

 

Balance, December 31, 2010

  

 

$

 

743

 

  

  

 

 

 

1,000

 

  

  

 

 

 

18,526,608

 

  

 

 

 

 

(406,478

 

 

 

 

 

18,121,873

 

  

 

 

 

Net income

     -         -         -        210,867        210,867   

Cash dividends

            

Series A preferred securities at $0.45 per share

     -         -         -        (13,594     (13,594

Series B preferred securities at $0.13 per share

     -         -         -        (5,332     (5,332

Series C preferred securities at $6.38 per share

     -         -         -        (27,020     (27,020

Common stock at $2.24 per share

     -         -         -        (224,000     (224,000

Common stock special capital distribution

     -         -         (2,500,000     -        (2,500,000

 

 

 

Balance, March 31, 2011

  

 

$

 

743

 

  

  

 

 

 

1,000

 

  

  

 

 

 

16,026,608

 

  

 

 

 

 

(465,557

 

 

 

 

 

15,562,794

 

  

 

 
Balance, December 31, 2011    $ 743         1,000         14,026,608        (525,908     13,502,443   

 

 

 

Net income

  

 

 

 

-

 

  

  

 

 

 

-

 

  

  

 

 

 

-

 

  

 

 

 

 

150,015

 

  

 

 

 

 

150,015

 

  

Cash dividends

            

Series A preferred securities at $0.45 per share

     -         -         -        (13,594     (13,594

Series B preferred securities at $0.15 per share

     -         -         -        (6,028     (6,028

Series C preferred securities at $7.08 per share

     -         -         -        (29,964     (29,964

Common stock at $1.50 per share

     -         -         -        (150,000     (150,000

 

 

Balance, March 31, 2012

  

 

$

 

                743

 

  

  

 

 

 

1,000

 

  

  

 

 

 

14,026,608

 

  

 

 

 

 

(575,479

 

 

 

 

 

13,452,872

 

  

 

 

The accompanying notes are an integral part of these statements.

 

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Financial Statements

Wachovia Preferred Funding Corp. and Subsidiaries

Consolidated Statement of Cash Flows (Unaudited)

 

          Quarter ended March 31,  
(in thousands)   

 

2012

    2011  

 

Cash flows from operating activities:

    

Net income

   $ 150,015        210,867   

Adjustments to reconcile net income to net cash provided (used) by operating activities:

    

Accretion of discounts on loans

     (34,674     (67,937

Provision for credit losses

     51,259        52,466   

Deferred income tax benefits

     (4,879     (4,924

Other operating activities, net

     1,119        (1,582

 

Net cash provided by operating activities

     162,840        188,890   

 

Cash flows from investing activities:

    

Increase (decrease) in cash realized from

    

Loans:

    

Purchases

     (943,508     -   

Proceeds from payments and sales

     843,563        1,501,753   

 

Net cash provided (used) by investing activities

     (99,945     1,501,753   

 

Cash flows from financing activities:

    

Decrease in cash realized from

    

Common stock special capital distributions

     -        (2,500,000

Cash dividends paid

     (13,594     (269,946

 

Net cash used by financing activities

     (13,594     (2,769,946

 

Net change in cash and cash equivalents

     49,301        (1,079,303

Cash and cash equivalents at beginning of period

     1,186,165        2,774,299   

 

Cash and cash equivalents at end of period

   $ 1,235,466        1,694,996   

 

Supplemental cash flow disclosures:

    

Cash paid for income taxes

   $ 5,500        4,000   

Change in non cash items:

    

Transfers from loans to foreclosed assets

     4,897        4,482   

    

                

The accompanying notes are an integral part of these statements.

 

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Note 1: Summary of Significant Accounting Policies

 

 

Wachovia Preferred Funding Corp. (Wachovia Funding) is a direct subsidiary of Wachovia Preferred Funding Holding Corp. (Wachovia Preferred Holding) and an indirect subsidiary of both Wells Fargo & Company (Wells Fargo) and Wells Fargo Bank, National Association (the Bank). Wachovia Funding is a real estate investment trust (REIT) for income tax purposes.

The accounting and reporting policies of Wachovia Funding are in accordance with U.S. generally accepted accounting principles (GAAP). Our significant accounting policies are discussed in our Form 10-K for the year ended December 31, 2011 (2011 Form 10-K). The preparation of the financial statements in accordance with GAAP requires management to make estimates based on assumptions about future economic and market conditions that affect the reported amounts of assets and liabilities at the date of the financial statements and income and expenses during the reporting period and the related disclosures. Although our estimates contemplate current conditions and how we expect them to change in the future, it is reasonably possible that actual future conditions could be worse than anticipated in those estimates, which could materially affect our results of operations and financial condition. Management has made significant estimates related to the allowance for credit losses (Note 2). Actual results could differ from those estimates.

The information furnished in these unaudited interim statements reflects all adjustments that are, in the opinion of management, necessary for a fair statement of the results for the periods presented. These adjustments are of a normal recurring nature, unless otherwise disclosed in this Form 10-Q. The results of operations in the interim statements do not necessarily indicate the results that may be expected for the full year. The interim financial information should be read in conjunction with our 2011 Form 10-K.

Accounting Standards Adopted in 2012

In first quarter 2012, we adopted Accounting Standards Update (ASU or Update) ASU 2011-4, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.

ASU 2011-04 modifies accounting guidance and expands existing disclosure requirements for fair value measurements. This Update clarifies how fair values should be measured for instruments classified in stockholders’ equity and under what circumstances premiums and discounts should be applied in fair value measurements. This Update also permits entities to measure fair value on a net basis for financial instruments that are managed based on net exposure to market risks and/or counterparty credit risk. ASU 2011-04 requires new disclosures for financial instruments classified as Level 3, including: 1) quantitative information about unobservable inputs used in measuring fair value, 2) qualitative discussion of the sensitivity of fair value measurements to changes in unobservable inputs, and 3) a description of valuation processes used. This Update also requires disclosure of fair

value levels for financial instruments that are not recorded at fair value but for which fair value is required to be disclosed. We adopted this guidance in first quarter 2012 with prospective application, resulting in expanded fair value disclosures. The measurement clarifications of this Update did not have a material effect on our consolidated financial statements.

Significant Accounting Policy Update

In first quarter 2012, we implemented the Interagency Supervisory Guidance on Allowance for Loan and Lease Losses Estimation Practices for Loans and Lines of Credit Secured by Junior Liens on 1-4 Family Residential Properties (Interagency Guidance), which was issued on January 31, 2012. As a result, we aligned our nonaccrual accounting policy with this guidance to accelerate the timing of placing junior lien loans on nonaccrual to coincide with the timing of placing the related real estate 1-4 family first mortgage loans on nonaccrual. Our updated nonaccrual policy is as follows:

We generally place loans on nonaccrual status when:

 

   

the full and timely collection of interest or principal becomes uncertain (generally based on an assessment of the borrower’s financial condition and the adequacy of collateral, if any);

 

   

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;

 

   

part of the principal balance has been charged off and no restructuring has occurred; or

 

   

effective first quarter 2012, for junior lien mortgages, we have evidence that the related first lien mortgage may be 120 days past due or in the process of foreclosure regardless of the junior lien delinquency status.

There have been no other material changes to our significant accounting policies, as discussed in Note 1 in our 2011 Form 10-K.

Subsequent Events

We have evaluated the effects of subsequent events that have occurred subsequent to period end March 31, 2012. During this period there have been no material events that would require recognition in our first quarter 2012 consolidated financial statements or disclosure in the Notes to Financial Statements.

 

 

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Note 2: Loans and Allowance for Credit Losses

 

 

Wachovia Funding obtains participation interests in loans originated or purchased by the Bank. By the nature of Wachovia Funding’s status as a REIT, the composition of the loans underlying the participation interests are highly concentrated in real estate. Underlying loans are concentrated primarily in Florida, New Jersey, Pennsylvania, North Carolina and Virginia. These markets include

approximately 60% of Wachovia Funding’s total loan balance at March 31, 2012.

The following table presents loans by segments and classes. Outstanding balances include a total net reduction of $570.7 million and $604.4 million at March 31, 2012 and December 31, 2011, respectively, for unearned discounts.

 

 

(in thousands)   

 

March 31,

2012

    

December 31,

2011

 

 

Commercial:

     

Commercial and industrial

   $ 281,512         287,174   

Real estate mortgage

     924,465         1,015,087   

Real estate construction

     39,821         45,887   

 

Total commercial

     1,245,798         1,348,148   

 

Consumer:

     

Real estate 1-4 family first mortgage

     8,124,256         7,945,746   

Real estate 1-4 family junior lien mortgage

     3,269,584         3,249,882   

 

Total consumer

     11,393,840         11,195,628   

 

Total loans

   $   12,639,638         12,543,776   

 

The following table summarizes the proceeds paid (excluding accrued interest receivable of $2.9 million in first

quarter 2012) or received from the Bank for purchases and sales of loans, respectively.

 

 

                    2012            2011  
  

 

 

            
(in thousands)    Commercial     Consumer     Total            Commercial     Consumer     Total  

 

Quarter ended March 31,

               

Purchases

   $                            -        940,618        940,618           -        -        -   

Sales

     (900     (16,312     (17,212          (5     (31,248     (31,253

Commitments to Lend

 

The contract or notional amount of commercial loan commitments to extend credit at March 31, 2012 and December 31, 2011 was $247.6 million and $329.6 million, respectively.

    

 

 

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Allowance for Credit Losses (ACL)

The ACL is management’s estimate of credit losses inherent in the loan portfolio, including unfunded credit commitments, at the balance sheet date. We have an established process to determine the adequacy of the allowance for credit losses that assesses the losses inherent in our portfolio and related unfunded credit commitments. While we attribute portions of the allowance to specific portfolio segments, the entire allowance is available to absorb credit losses inherent in the total loan portfolio and unfunded credit commitments.

Our process involves procedures to appropriately consider the unique risk characteristics of our commercial and consumer loan portfolio segments. For each portfolio segment, impairment is measured collectively for groups of smaller loans with similar characteristics or individually for larger impaired loans.

Our allowance levels are influenced by loan volumes, loan grade migration or delinquency status, historic loss experience influencing loss factors, and other conditions influencing loss expectations, such as economic conditions.

COMMERCIAL PORTFOLIO SEGMENT ACL METHODOLOGY

Generally, commercial loans are assessed for estimated losses by grading each loan using various risk factors as identified through periodic reviews. We apply historic grade-specific loss factors to the aggregation of each funded grade pool. These historic loss factors are also used to estimate losses for unfunded credit commitments. In the development of our statistically derived loan grade loss factors, we observe historical losses over a relevant period for each loan grade. These loss estimates are adjusted as appropriate based on additional analysis of long-term average loss experience compared to previously forecasted losses, external loss data or other risks identified from current economic conditions and credit quality trends.

The allowance also includes an amount for the estimated impairment on nonaccrual commercial loans and commercial loans modified in a TDR, whether on accrual or nonaccrual status.

CONSUMER PORTFOLIO SEGMENT ACL METHODOLOGY For consumer loans, not identified as a TDR, we determine the allowance on a collective basis utilizing forecasted losses to represent our best estimate of inherent loss. We pool loans, generally by product types with similar risk characteristics, such as residential real estate mortgages. As appropriate, to achieve greater accuracy, we may further stratify selected portfolios by sub-product or other predictive characteristics. Models designed for each pool are utilized to develop the loss estimates. We use assumptions for these pools in our forecast models, such as historic delinquency and default, loss severity, home price trends, unemployment trends, and other key economic variables that may influence the frequency and severity of losses in the pool.

In determining the appropriate allowance attributable to our residential mortgage portfolio, we incorporate the default rates and high severity of loss for junior lien mortgages behind delinquent first lien mortgages into our loss forecasting calculations. In addition, the loss rates we use in determining our allowance include the impact of our established loan modification programs. When modifications occur or are probable to occur, our allowance considers the impact of these modifications, taking into consideration the associated credit cost, including re-defaults of modified loans and projected loss severity. Accordingly, the loss content associated with the effects of existing and probable loan modifications and junior lien mortgages behind delinquent first lien mortgages has been considered in our allowance methodology.

We separately estimate impairment for consumer loans that have been modified in a TDR (including trial modifications), whether on accrual or nonaccrual status.

OTHER ACL MATTERS The ACL for both portfolio segments includes an amount for imprecision or uncertainty that may change from period to period. This amount represents management’s judgment of risks inherent in the processes and assumptions used in establishing the allowance. This imprecision considers economic environmental factors, modeling assumptions and performance, process risk, and other subjective factors, including industry trends.

Impaired loans, which predominately include nonaccrual commercial loans and any loans that have been modified in a TDR, have an estimated allowance calculated as the difference, if any, between the impaired value of the loan and the recorded investment in the loan. The impaired value of the loan is generally calculated as the present value of expected future cash flows from principal and interest which incorporates expected lifetime losses, discounted at the loan’s effective interest rate. The allowance for an impaired loan that was modified as a TDR may be lower than the previously established allowance for that loan due to benefits received through modification, such as lower probability of default and/or severity of loss, and the impact of prior charge-offs or charge-offs at the time of the modification that may reduce or eliminate the need for an allowance.

 

 

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Table of Contents

    The allowance for credit losses consists of the allowance for loan losses and the allowance for unfunded credit commitments. Changes in the allowance for credit losses were:

 

     

 

Quarter ended March 31,

 
(in thousands)   

 

2012  

   

 

2011 

 

 

 

Balance, beginning of quarter

   $         313,928          403,555    

Provision for credit losses

     51,259          52,466    

Interest income on certain impaired loans (1)

     (1,901)         (1,081)   

Loan charge-offs:

    

Commercial:

    

Commercial and industrial

     -            

Real estate mortgage

     (252)         (43)   

Total commercial

     (252)         (43)   

 

Consumer:

    

Real estate 1-4 family first mortgage

     (23,324)         (23,400)   

Real estate 1-4 family junior lien mortgage

     (32,422)         (44,747)   

 

Total consumer

     (55,746)         (68,147)   

Total loan charge-offs

     (55,998)         (68,190)   

 

Loan recoveries:

    

Commercial:

    

Commercial and industrial

     -            

Real estate mortgage

     4          85    

 

Total commercial

     4          85    

Consumer:

    

Real estate 1-4 family first mortgage

     459          431    

Real estate 1-4 family junior lien mortgage

     2,362          2,352    

Total consumer

     2,821          2,783    

Total loan recoveries

     2,825          2,868    

 

Net loan charge-offs

     (53,173)         (65,322)   

 

Balance, end of quarter

   $ 310,113          389,618    

 

Components:

    

Allowance for loan losses

   $ 309,913          389,310    

Allowance for unfunded credit commitments

     200          308    

 

Allowance for credit losses

   $ 310,113          389,618    

 

Net loan charge-offs as a percentage of average total loans

     1.74       1.78    

Allowance for loan losses as a percentage of total loans

     2.45          2.73    

Allowance for credit losses as a percentage of total loans

     2.45          2.73    

 

  (1) Certain impaired loans with an allowance calculated by discounting expected cash flows using the loan’s effective interest rate over the remaining life of the loan recognize reductions in allowance as interest income.

 

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Table of Contents

    The following table summarizes the activity in the allowance for credit losses by our commercial and consumer portfolio segments.

 

 

 

          Quarter ended March 31,  
          2012     2011  
(in thousands)         

 

Commercial

    Consumer     Total     Commercial     Consumer     Total  

 

Balance, beginning of quarter

   $      23,091        290,837        313,928        26,413        377,142        403,555   

Provision for credit losses

        (2,886     54,145        51,259        (3,505     55,971        52,466   

Interest income on certain impaired loans

        -        (1,901     (1,901     -        (1,081     (1,081

Loan charge-offs

        (252     (55,746     (55,998     (43     (68,147     (68,190

Loan recoveries

          4        2,821        2,825        85        2,783        2,868   

Net loan charge-offs

          (248     (52,925     (53,173     42        (65,364     (65,322

 

Balance, end of quarter

   $      19,957        290,156        310,113        22,950        366,668        389,618   

    The following table disaggregates our allowance for credit losses and recorded investment in loans by impairment methodology.

 

 

 

            Allowance for credit losses      Recorded investment in loans  
(in thousands)            Commercial      Consumer      Total      Commercial      Consumer     

 

Total

 

March 31, 2012

                    

Collectively evaluated (1)

   $           12,188         189,668         201,856         1,221,133         11,007,063         12,228,196   

Individually evaluated (2)

        7,769         100,488         108,257         18,097         332,878         350,975   

Purchased credit-impaired (PCI) (3)

              -         -         -         6,568         53,899         60,467   

Total

   $           19,957         290,156         310,113         1,245,798         11,393,840         12,639,638   

December 31, 2011

                    

Collectively evaluated (1)

   $           12,487         188,604         201,091         1,320,845         10,815,112         12,135,957   

Individually evaluated (2)

        10,436         102,233         112,669         20,198         324,605         344,803   

PCI (3)

              168         -         168         7,105         55,911         63,016   

Total

   $           23,091         290,837         313,928         1,348,148         11,195,628         12,543,776   

 

(1) Represents loans collectively evaluated for impairment in accordance with ASC 450-20, Loss Contingencies (formerly FAS 5), and pursuant to amendments by ASU 2010-20 regarding allowance for unimpaired loans.
(2) Represents loans individually evaluated for impairment in accordance with ASC 310-10, Receivables (formerly FAS 114), and pursuant to amendments by ASU 2010-20 regarding allowance for impaired loans.
(3) Represents the allowance and related loan carrying value determined in accordance with ASC 310-30, Receivables – Loans and Debt Securities Acquired with Deteriorated Credit Quality (formerly SOP 03-3) and pursuant to amendments by ASU 2010-20 regarding allowance for PCI loans.

 

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Table of Contents

Credit Quality

We monitor credit quality as indicated by evaluating various attributes and utilize such information in our evaluation of the adequacy of the allowance for credit losses. The following sections provide the credit quality indicators we most closely monitor. The majority of credit quality indicators are based on March 31, 2012, information, with the exception of updated Fair Isaac Corporation (FICO) scores and updated loan-to-value (LTV)/combined LTV (CLTV), which are obtained at least quarterly. Generally, these indicators are updated in the second month of each quarter, with updates no older than December 31, 2011.

COMMERCIAL CREDIT QUALITY INDICATORS In addition to monitoring commercial loan concentration risk, we manage a consistent process for assessing commercial loan credit quality. Generally commercial loans are subject to individual risk assessment using our internal borrower and collateral quality ratings. Our ratings are aligned to Pass and Criticized categories. The Criticized category includes Special Mention, Substandard, and Doubtful categories which are defined by bank regulatory agencies.

The table below provides a breakdown of outstanding commercial loans by risk category.

 

 

         
(in thousands)    Commercial
and
industrial
    

Real

estate
mortgage

    

Real

estate
construction

     Total  

March 31, 2012

           

By risk category:

           

Pass

   $ 280,573         771,818         32,871         1,085,262   

Criticized

     939         152,647         6,950         160,536   

 

Total commercial loans

   $ 281,512         924,465         39,821         1,245,798   

December 31, 2011

           

By risk category:

           

Pass

   $ 286,228         852,464         35,705         1,174,397   

Criticized

     946         162,623         10,182         173,751   

 

Total commercial loans

   $ 287,174         1,015,087         45,887         1,348,148   

  In addition, while we monitor past due status, we do not consider it a key driver of our credit risk management practices for commercial loans. The following table provides past due information for commercial loans.

 

(in thousands)   

 

Commercial
and
industrial

    

Real

estate
mortgage

    

Real

estate
construction

     Total  

 

March 31, 2012

           

By delinquency status:

           

Current-29 days past due (DPD) and still accruing

   $ 281,373         892,794         39,641         1,213,808   

30-89 DPD and still accruing

     139         13,048         -         13,187   

90+ DPD and still accruing

     -         -         -         -   

Nonaccrual loans

     -         18,623         180         18,803   

 

Total commercial loans

   $ 281,512         924,465         39,821         1,245,798   

 

December 31, 2011

           

By delinquency status:

           

Current-29 DPD and still accruing

   $ 282,703         943,712         45,636         1,272,051   

30-89 DPD and still accruing

     4,471         48,320         -         52,791   

90+ DPD and still accruing

     -         1,923         -         1,923   

Nonaccrual loans

     -         21,132         251         21,383   

 

Total commercial loans

   $ 287,174         1,015,087         45,887         1,348,148   

 

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Table of Contents

CONSUMER CREDIT QUALITY INDICATORS We have various classes of consumer loans that present respective unique risks. Loan delinquency, FICO credit scores and LTV/CLTV for loan types are common credit quality indicators that we monitor and utilize in our evaluation of the adequacy of the allowance for credit losses for the consumer portfolio segment.

The majority of our loss estimation techniques used for the allowance for credit losses rely on delinquency matrix models or delinquency roll rate models. Therefore, delinquency is an important indicator of credit quality and the establishment of our allowance for credit losses.

 

 

    The following table provides the outstanding balances of our consumer portfolio by delinquency status.

 

 

 
(in thousands)   

 

Real estate

1-4 family

first

mortgage

     Real estate
1-4 family
junior lien
mortgage
     Total  

 

 

March 31, 2012

        

By delinquency status:

        

Current - 29 DPD

   $             7,832,553          3,140,517          10,973,070    

30-59 DPD

     68,301          37,622          105,923    

60-89 DPD

     45,002          24,251          69,253    

90-119 DPD

     28,298          18,219          46,517    

120-179 DPD

     40,868          24,720          65,588    

180+ DPD

     126,453          27,642          154,095    

Remaining PCI accounting adjustments

     (17,219)         (3,387)         (20,606)   

Total consumer loans

   $             8,124,256          3,269,584          11,393,840    

December 31, 2011

        

By delinquency status:

        

Current - 29 DPD

   $             7,645,674          3,098,012          10,743,686    

30-59 DPD

     80,409          48,886          129,295    

60-89 DPD

     42,387          27,824          70,211    

90-119 DPD

     34,471          21,434          55,905    

120-179 DPD

     39,314          28,939          68,253    

180+ DPD

     120,819          28,874          149,693    

Remaining PCI accounting adjustments

     (17,328)         (4,087)         (21,415)   

Total consumer loans

   $             7,945,746          3,249,882          11,195,628    

 

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Table of Contents

The following table provides a breakdown of our consumer portfolio by updated FICO. We obtain FICO scores at loan origination and the scores are updated at least

quarterly. FICO is not available for certain loan types and may not be obtained if we deem it unnecessary due to strong collateral and other borrower attributes.

 

 

 

 
(in thousands)   

Real estate

1-4 family

first

mortgage

     Real estate
1-4 family
junior lien
mortgage
     Total  

 

 

March 31, 2012

        

By updated FICO:

        

< 600

   $ 537,442          379,503          916,945    

600-639

     338,540          187,654          526,194    

640-679

     589,646          318,679          908,325    

680-719

     1,197,708          532,917          1,730,625    

720-759

     1,570,201          663,443          2,233,644    

760-799

     2,378,976          751,826          3,130,802    

800+

     1,370,953          399,208          1,770,161    

No FICO available

     158,009          39,741          197,750    

Remaining PCI accounting adjustments

     (17,219)         (3,387)         (20,606)   

Total consumer loans

   $ 8,124,256          3,269,584          11,393,840    

December 31, 2011

        

By updated FICO:

        

< 600

   $ 537,949          387,232          925,181    

600-639

     321,284          195,122          516,406    

640-679

     572,899          331,988          904,887    

680-719

     1,128,538          514,089          1,642,627    

720-759

     1,542,772          634,491          2,177,263    

760-799

     2,324,799          757,186          3,081,985    

800+

     1,338,881          384,579          1,723,460    

No FICO available

     195,952          49,282          245,234    

Remaining PCI accounting adjustments

     (17,328)         (4,087)         (21,415)   

Total consumer loans

   $         7,945,746          3,249,882          11,195,628    

 

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Table of Contents

LTV refers to the ratio comparing the loan’s balance to the property’s collateral value. CLTV refers to the combination of first mortgage and junior lien mortgage ratios. LTVs and CLTVs are updated quarterly using a cascade approach which first uses values provided by automated valuation models (AVMs) for the property. If an AVM is not available, then the value is estimated using the original appraised value adjusted by the change in Home Price Index (HPI) for the property location. If an HPI is not available, the original appraised value is used. The HPI value is normally the only method considered for high value properties as the AVM values have proven less accurate for these properties.

The following table shows the most updated LTV and CLTV distribution of the real estate 1-4 family first and junior

lien mortgage loan portfolios. The residential real estate markets remain weak and continue to experience declines in property values in some states. These trends are considered in the way that we monitor credit risk and establish our allowance for credit losses. LTV does not necessarily reflect the likelihood of performance of a given loan, but does provide an indication of collateral value. In the event of a default, any loss should be limited to the portion of the loan amount in excess of the net realizable value of the underlying real estate collateral value. Certain loans do not have an LTV or CLTV primarily due to industry data availability and portfolios acquired from or serviced by other institutions.

 

 

 

 
(in thousands)   

Real estate

1-4 family

first

mortgage

by LTV

     Real estate
1-4 family
junior lien
mortgage
by CLTV
     Total  

 

 

March 31, 2012

        

By LTV/CLTV:

        

0-60%

   $ 3,594,912          679,526          4,274,438    

60.01-80%

     2,386,859          684,459          3,071,318    

80.01-100%

     1,305,167          789,611          2,094,778    

100.01-120% (1)

     493,843          592,086          1,085,929    

> 120% (1)

     316,068          522,507          838,575    

No LTV/CLTV available

     44,626          4,782          49,408    

Remaining PCI accounting adjustments

     (17,219)         (3,387)         (20,606)   

Total consumer loans

   $ 8,124,256          3,269,584          11,393,840    

December 31, 2011

        

By LTV/CLTV:

        

0-60%

   $ 3,764,740          676,585          4,441,325    

60.01-80%

     2,273,111          599,394          2,872,505    

80.01-100%

     1,098,818          812,647          1,911,465    

100.01-120% (1)

     473,691          614,633          1,088,324    

> 120% (1)

     303,808          545,323          849,131    

No LTV/CLTV available

     48,906          5,387          54,293    

Remaining PCI accounting adjustments

     (17,328)         (4,087)         (21,415)   

Total consumer loans

   $         7,945,746          3,249,882          11,195,628    

 

(1) Reflects total loan balances with LTV/CLTV amounts in excess of 100%. In the event of default, the loss content would generally be limited to only the amount in excess of 100% LTV/CLTV.

 

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Table of Contents

NONACCRUAL LOANS The following table provides loans on nonaccrual status. PCI loans are excluded from this table due to the existence of the accretable yield.

 

     
(in thousands)    Mar. 31
2012 
     Dec. 31,
2011 
 

Commercial:

     

Commercial and industrial

   $ -         -   

Real estate mortgage

     18,623         21,132   

Real estate construction

     180         251   

Total commercial

     18,803         21,383   

Consumer:

     

Real estate 1-4 family first mortgage

     235,737         228,363   

Real estate 1-4 family junior lien mortgage (1)

     152,824         99,347   

Total consumer

     388,561         327,710   

Total nonaccrual loans

     

(excluding PCI)

   $     407,364         349,093   

 

(1) Includes $55.2 million at March 31, 2012, resulting from implementation of the Interagency Guidance issued on January 31, 2012. This guidance accelerated the timing of placing these loans on nonaccrual to coincide with the timing of placing the related real estate 1-4 family first mortgage loans on nonaccrual.

LOANS 90 DAYS OR MORE PAST DUE AND STILL ACCRUING Certain loans 90 days or more past due as to interest or principal are still accruing, because they are (1) well-secured and in the process of collection or (2) real estate 1-4 family mortgage loans exempt under regulatory rules from being classified as nonaccrual until later delinquency, usually 120 days past due. PCI loans of $7.1 million at March 31, 2012, and $7.6 million at December 31, 2011, are excluded from this disclosure even though they are 90 days or more contractually past due. These PCI loans are considered to be accruing due to the existence of the accretable yield and not based on consideration given to contractual interest payments.

The following table shows non-PCI loans 90 days or more past due and still accruing.

 

     
(in thousands)    Mar. 31,
2012 
     Dec. 31,
2011 
 

Commercial:

     

Commercial and industrial

   $ -         -   

Real estate mortgage

     -         1,596   

Real estate construction

     -         -   

Total commercial

     -         1,596   

Consumer:

     

Real estate 1-4 family first mortgage

     16,211         21,008   

Real estate 1-4 family junior lien mortgage (1)

     5,560         15,492   

Total consumer

     21,771         36,500   

Total past due (excluding PCI)

   $     21,771         38,096   

 

(1) During first quarter 2012, $2.7 million of 1-4 family junior lien mortgages were transferred to nonaccrual upon implementation of the Interagency Guidance issued on January 31, 2012.
 

 

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Table of Contents

IMPAIRED LOANS The table below summarizes key information for impaired loans. Our impaired loans predominately include loans on nonaccrual status in the commercial portfolio segment and loans modified in a TDR, whether on accrual or nonaccrual status. These impaired loans may have estimated loss which is included in the allowance for credit losses. Impaired loans exclude PCI loans.

Based on clarifying guidance from the Securities and Exchange Commission (SEC) received in December 2011, we now classify trial modifications as TDRs at the beginning of the trial period. The table below includes trial modifications that totaled $23.7 million at March 31, 2012 and $21.4 million at December 31, 2011.

 

 

     
   

            Recorded investment

       
(in thousands)   Unpaid
principal
balance
    Impaired
loans
   

 

Impaired loans
with related
allowance for
credit losses

    Related
allowance for
credit losses
 

March 31, 2012

       

Commercial:

       

Commercial and industrial

  $ -        -        -        -   

Real estate mortgage

    23,296        17,917        17,917        7,669   

Real estate construction

    195        180        180        100   

Total commercial

    23,491        18,097        18,097