SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
Annual report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”) for the fiscal year ended December 31, 2006 Commission file number 1-10000
WACHOVIA CORPORATION
(Exact name of registrant as specified in its charter)
NORTH CAROLINA
(State of incorporation)
56-0898180
(I.R.S. Employer Identification No.)
ONE WACHOVIA CENTER CHARLOTTE, NC
(Address of principal executive offices)
28288-0013
(Zip Code)
Registrant’s telephone number, including area code: (704) 374-6565 Securities registered pursuant to Section 12(b) of the Exchange Act:
TITLE OF EACH CLASS Common Stock, $3.33 1/3 par value (including attached rights) 5.80% Fixed-to-Floating Rate Normal Wachovia Income Trust Securities fully and unconditionally guaranteed by Wachovia Corporation 6.375% Trust Preferred Securities of Wachovia Capital Trust IV fully and unconditionally guaranteed by Wachovia Corporation Commodity-Linked Notes due November 3, 2008 Commodity-Linked Notes due August 6, 2009 NAME OF EXCHANGE ON WHICH REGISTERED New York Stock Exchange, Inc. (the “NYSE”) NYSE NYSE NYSE NYSE
See full list of securities listed on the American Stock Exchange on the page directly following this cover page
Securities registered pursuant to Section 12(g) of the Exchange Act:
TITLE OF EACH CLASS Dividend Equalization Preferred shares, no par value Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [X] No [ ] Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes [ ] No [X] Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10K. [ ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. Large accelerated filer [X] Accelerated filer [ ] Non-accelerated filer [ ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] As of June 30, 2006, the last business day of the registrant’s completed second fiscal quarter, the aggregate market value of the voting and non-voting common equity held by non-affiliates was approximately $85.5 billion. As of January 31, 2007, there were 1,905,742,204 shares of the registrant’s common stock outstanding, $3.33 1/3 par value per share.
DOCUMENTS INCORPORATED BY REFERENCE IN FORM 10-K
1. INCORPORATED DOCUMENTS Certain portions of the Corporation’s Annual Report to Stockholders for the year ended December 31, 2006 (“Annual Report”). Certain portions of the Corporation’s Proxy Statement for the Annual Meeting of Stockholders to be held April 17, 2007 (“Proxy Statement”). WHERE INCORPORATED IN FORM 10-K Part I -- Items 1 and 2; Part II -- Items 5, 6, 7, 7A, 8 and 9A; and Part IV – Item 15. Part III -- Items 10, 11, 12, 13 and 14.
2.
Securities registered pursuant to Section 12(b) of the Exchange Act and listed on the American Stock Exchange are as follows:
Participating Index Notes (PINS) TEES Targeted Efficient Equity Securities Linked to the S&P 500® Index due August 19, 2009; Trigger CAPITALS (Covered Asset ParticIpation Target exchAngeabLe Securities) Linked to the S&P 500® Composite Stock Price Index due December 8, 2008; ASTROS (ASseT Return Obligation Securities) Linked to the Nikkei 225® Index Due March 2, 2010; ASTROS (ASseT Return Obligation Securities) Linked to a Global Basket of Indices due February 2, 2010; ASTROS (ASseT Return Obligation Securities) Linked to the Dow Jones Global Titans 50 Index due March 3, 2010; ASTROS (ASseT Return Obligation Securities) Linked to the Global Equity Basket (Series 2005-2) due May 5, 2010; LUNARS (Leveraged Upside iNdexed Accelerated Return Securities) Linked to the Nikkei 225® Index due April 30, 2007; Exchangeable Notes Linked to the Common Stock of Three Oil Industry Companies due December 15, 2010; Principal Protected Notes Linked to a Basket of Asian Currencies due December 6, 2008 Offering 100% Principal Protection; Principal Protected Notes Linked to a Basket of Emerging Market Currencies due April 6, 2008 Offering 100% Principal Protection; 19.25% Enhanced Yield Securities Linked to the Common Stock of General Motors Corporation due July 10, 2007; ASTROS (ASseT Return Obligation Securities) Linked to the Metals – China Basket due January 28, 2009; 90% Principal Protected Notes due June 6, 2007 Linked to the Performance of the 4.5% U.S. Treasuries due February 15, 2036; 9.375% Enhanced Yield Securities Linked to the Common Stock of Transocean Inc. due May 15, 2007; 11.25% Enhanced Yield Securities Linked to the Common Stock of Toll Brothers, Inc. due May 15, 2007; 10% Enhanced Yield Securities Linked to the Common Stock of Consol Energy Inc. due April 20, 2007; 10.25% Enhanced Yield Securities Linked to the Common Stock of Valero Energy Corporation due March 12, 2007; and 14% Enhanced Yield Securities Linked to the Common Stock of Advanced Micro Devices, Inc. due March 12, 2007
PART I Wachovia Corporation (formerly named First Union Corporation, “Wachovia”) may from time to time make written or oral forward-looking statements, including statements contained in Wachovia’s filings with the Securities and Exchange Commission (including this Annual Report on Form 10-K and the Exhibits hereto), in its reports to stockholders and in other Wachovia communications. These statements relate to future, not past, events. These forward-looking statements include, among others, statements with respect to Wachovia’s beliefs, plans, objectives, goals, guidelines, expectations, financial condition, results of operations, future performance and business, including without limitation, (i) statements relating to the benefits of the merger (including divestitures related thereto) between Wachovia and Golden West Financial Corporation (the “Golden West Merger”) completed on October 1, 2006, including future financial and operating results, cost savings, enhanced revenues and the accretion or dilution to reported earnings that may be realized from the Golden West Merger, (ii) statements relating to the benefits of the merger among Wachovia, Westcorp and WFS Financial Inc (the “Westcorp Merger” and together with the Golden West Merger, the “Mergers”), completed on March 1, 2006, including future financial and operating results, cost savings, enhanced revenues and the accretion or dilution to reported earnings that may be realized from the Westcorp Merger, (iii) statements regarding Wachovia’s goals and expectations with respect to earnings, earnings per share, revenue, expenses and the growth rate in such items, as well as other measures of economic performance, including statements relating to estimates of credit quality trends, and (iv) statements preceded by, followed by or that include the words “may”, “could”, “should”, “would”, “believe”, “anticipate”, “estimate”, “expect”, “intend”, “plan”, “projects”, “outlook” or similar expressions. These forward-looking statements are based upon the current beliefs and expectations of Wachovia’s management and are subject to significant risks and uncertainties that are subject to change based on various factors (many of which are beyond Wachovia’s control). Actual results may differ from those set forth in the forward-looking statements. The following factors, among others, could cause Wachovia’s financial performance to differ materially from that expressed in any forward-looking statements: (1) the risk that the businesses of Wachovia and Golden West in connection with the Golden West Merger or the businesses of Wachovia, Westcorp and WFS Financial Inc in connection with the Westcorp Merger will not be integrated successfully or such integration may be more difficult, time-consuming or costly than expected; (2) expected revenue synergies and cost savings from the Mergers may not be fully realized or realized within the expected time frame; (3) revenues following the Mergers may be lower than expected; (4) deposit attrition, operating costs, customer loss and business disruption following the Mergers, including, without limitation, difficulties in maintaining relationships with employees, may be greater than expected; (5) the strength of the United States economy in general and the strength of the local economies in which Wachovia conducts operations may be different than expected, resulting in, among other things, a deterioration in credit quality or a reduced demand for credit, including the resultant effect on Wachovia’s loan portfolio and allowance for loan losses; (6) the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; (7) inflation, interest rate, market and monetary fluctuations; (8) adverse conditions in the stock market, the public debt market and other capital markets (including changes in interest rate conditions) and the impact of such conditions on Wachovia’s capital markets and capital management activities, including, without limitation, Wachovia’s mergers and acquisition advisory business, equity and debt underwriting activities, private equity investment activities, derivative securities activities, investment and wealth management advisory businesses, and brokerage activities; (9) the timely development of competitive new products and services by Wachovia and the acceptance of these products and services by new and existing customers; (10) the willingness of customers to accept third party products marketed by Wachovia; (11) the willingness of customers to substitute competitors’ products and services for Wachovia’s products and services and vice versa; (12) the impact of changes in financial services laws and regulations (including laws concerning taxes, banking, securities and insurance); (13) technological changes; (14) changes in consumer spending and saving habits; (15) the effect of corporate restructurings, acquisitions and/or dispositions we may undertake from time to time, and the actual restructuring and other expenses related thereto, and the failure to achieve the expected revenue growth and/or expense savings from such corporate restructurings, acquisitions and/or dispositions; (16) the growth and profitability of Wachovia’s noninterest or fee income being less than expected; (17) unanticipated regulatory or judicial proceedings or rulings; (18) the impact of changes in accounting principles; (19) adverse changes in financial performance and/or condition of Wachovia’s borrowers which could impact repayment of such borrowers’ outstanding loans; (20) the impact on Wachovia’s businesses, as well as on the risks set forth above, of various domestic or international military or terrorist activities or conflicts; and (21) Wachovia’s success at managing the risks involved in the foregoing. Wachovia cautions that the foregoing list of important factors is not exclusive. Wachovia does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of Wachovia.
ITEM 1. GENERAL
BUSINESS.
Wachovia was incorporated under the laws of North Carolina in 1967 and is registered as a financial holding company and a bank holding company under the Bank Holding Company Act of 1956, as amended. The merger of the former Wachovia Corporation (“Legacy Wachovia”) and First Union Corporation (“Legacy First Union”) was effective September 1, 2001. Legacy First Union changed its name to “Wachovia Corporation” on the date of the merger. As the surviving corporate entity in the merger, information contained in this Annual Report on Form 10-K, unless indicated otherwise, includes information about Legacy First Union only. Whenever we use the “Wachovia” name in this Annual Report on Form 10-K, we mean the new combined company and, before the merger, Legacy First Union, unless indicated otherwise. We provide a wide range of commercial and retail banking and trust services through full-service banking offices in Alabama, Arizona, California, Colorado, Connecticut, Delaware, Florida, Georgia, Illinois, Kansas, Maryland, Mississippi, Nevada, New Jersey, New York, North Carolina, Pennsylvania, South Carolina, Tennessee, Texas, Virginia and Washington, D.C. Our primary banking affiliate, Wachovia Bank, National Association (“WBNA”), operates a substantial majority of these banking offices, except those in Delaware, which are operated by Wachovia Bank of Delaware, National Association, and except those in Arizona, Colorado, Illinois, Kansas, Nevada and certain branch offices in California, Florida, New Jersey and Texas, which are operated by World Savings Bank, FSB (“World Savings”). We also provide various other financial services, including mortgage banking, investment banking, investment advisory, home equity lending, asset-based lending, leasing, insurance, international and securities brokerage services, through other subsidiaries. Our retail securities brokerage business is conducted through Wachovia Securities, LLC, and operates in 49 states. Our principal executive offices are located at One Wachovia Center, 301 South College Street, Charlotte, North Carolina 282880013 (telephone number (704) 374-6565). Since the 1985 Supreme Court decision allowing interstate banking expansion, we have concentrated our efforts on building a large, diversified financial services organization, primarily doing business in the eastern region of the United States. Since November 1985, we have completed over 100 banking-related acquisitions. Our business focus is on generating improved core earnings growth from our four key businesses, including Capital Management, the General Bank, Wealth Management, and the Corporate and Investment Bank. We will continue to evaluate our operations and organizational structures to ensure they are closely aligned with our goal of maximizing performance in our core business lines. When consistent with our overall business strategy, we may consider the disposition of certain assets, branches, subsidiaries or lines of business. We routinely explore acquisition opportunities, particularly in areas that would complement our core business lines, and frequently conduct due diligence activities in connection with possible acquisitions. As a result, acquisition discussions and, in some cases, negotiations frequently take place and future acquisitions involving cash, debt or equity securities can be expected. Additional information relating to our businesses and our subsidiaries is included in the information set forth on pages 21 through 27 and in Note 14 on pages 100 through 102 in the Annual Report and incorporated herein by reference. Information relating to Wachovia Corporation only is set forth in Note 22 on pages 127 through 129 in the Annual Report and incorporated herein by reference. Available Information Wachovia’s Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are accessible at no cost on our website, www.wachovia.com, as soon as reasonably practicable after those reports have been electronically filed or submitted to the SEC. These filings are also accessible on the SEC’s website, www.sec.gov. In addition, Wachovia makes available on www.wachovia.com (i) its Corporate Governance Guidelines, (ii) its Director Independence Standards, (iii) its Code of Conduct & Ethics, which applies to its directors and all employees, and (iv) the charters of the Audit, Management Resources & Compensation, and Corporate Governance & Nominating Committees of its Board of Directors. These materials also are available free of charge in print to stockholders who request them by writing to: Investor Relations, Wachovia Corporation, 301 South College Street, Charlotte, North Carolina 28288-0206. Wachovia also makes available through our website statements of beneficial ownership of Wachovia’s equity securities filed by our directors, officers and 10% or greater shareholders under Section 16 of the Securities Exchange Act of 1934. The information on our website is not incorporated by reference into this report. COMPETITION Our subsidiaries face substantial competition in their operations from banking and non-banking institutions, including savings
and loan associations, credit unions, money market funds and other investment vehicles, mutual fund advisory companies, brokerage firms, insurance companies, leasing companies, credit card issuers, mortgage banking companies, investment banking companies, finance companies and other types of financial services providers, including Internet-only financial service providers. REGULATION AND SUPERVISION The following discussion sets forth some of the material elements of the regulatory framework applicable to financial holding companies and bank holding companies and their subsidiaries and provides some specific information relevant to us. The regulatory framework is intended primarily for the protection of depositors and the Bank Insurance Fund and not for the protection of security holders and creditors. To the extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provisions. The current regulatory environment for financial institutions includes substantial enforcement activity by the federal banking agencies, the U.S. Department of Justice, the Securities and Exchange Commission and other state and federal law enforcement agencies, reflecting an increase in activity over prior years. This environment entails significant potential increases in compliance requirements and associated costs. A number of banking institutions have recently been subject to enforcement actions as well as settlements involving, among other things, cease and desist orders, written agreements, deferred prosecutions and payments of monetary penalties. Bank Holding Company Activities General As a financial holding company and a bank holding company, Wachovia is regulated under the Bank Holding Company Act of 1956, as well as other federal and state laws governing the banking business. The Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) is the primary regulator of Wachovia, and supervises our activities on a continual basis. Our subsidiaries are also subject to regulation and supervision by various regulatory authorities, including the Federal Reserve Board, the Comptroller of the Currency (the “Comptroller”), the Office of Thrift Supervision (the “OTS”) and the Federal Deposit Insurance Corporation (the “FDIC”). The Gramm-Leach-Bliley Financial Modernization Act of 1999 was enacted on November 12, 1999. The Modernization Act, which amended the Bank Holding Company Act, • • • • allows bank holding companies that qualify as “financial holding companies” to engage in a broad range of financial and related activities; allows insurers and other financial services companies to acquire banks; removes various restrictions that applied to bank holding company ownership of securities firms and mutual fund advisory companies; and establishes the overall regulatory structure applicable to bank holding companies that also engage in insurance and securities operations.
The Federal Reserve Board notified us that, effective March 13, 2000, we are authorized to operate as a financial holding company and therefore are eligible to engage in, or acquire companies engaged in, the broader range of activities that are permitted by the Modernization Act. These activities include those that are determined to be “financial in nature”, including insurance underwriting, securities underwriting and dealing, and making merchant banking investments in commercial and financial companies. If any of our banking subsidiaries ceases to be “well capitalized” or “well managed” under applicable regulatory standards, the Federal Reserve Board may, among other things, place limitations on our ability to conduct these broader financial activities or, if the deficiencies persist, require us to divest the banking subsidiary. In addition, if any of our banking subsidiaries receives a rating of less than satisfactory under the Community Reinvestment Act of 1977 (“CRA”), we would be prohibited from engaging in any additional activities other than those permissible for bank holding companies that are not financial holding companies. Our banking subsidiaries currently meet these capital, management and CRA requirements. Interstate Banking The Reigle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “IBBEA”) authorized interstate acquisitions of banks and bank holding companies without geographic limitation. Under IBBEA a bank holding company cannot make an interstate acquisition of a bank if, as a result, it would control more than 10% of the total United States insured depository deposits and more than 30% or the applicable state law limit of deposits in that state.
Banking Acquisitions As a bank holding company, we are required to obtain prior Federal Reserve Board approval before acquiring more than 5% of the voting shares, or substantially all of the assets, of a bank holding company, bank or savings association. In determining whether to approve a proposed bank acquisition, federal bank regulators will consider, among other factors, the effect of the acquisition on competition, the public benefits expected to be received from the acquisition, the projected capital ratios and levels on a post-acquisition basis, and the acquiring institution's record of addressing the credit needs of the communities it serves, including the needs of low and moderate income neighborhoods, consistent with the safe and sound operation of the bank, under the CRA. Subsidiary Dividends Wachovia is a legal entity separate and distinct from its banking and other subsidiaries. A major portion of our revenues results from amounts paid as dividends to us by our bank subsidiaries. The Comptroller’s prior approval is required if the total of all dividends declared by a national bank in any calendar year will exceed the sum of that bank’s net profits for that year and its retained net profits for the preceding two calendar years, less any required transfers to surplus. Federal law also prohibits national banks from paying dividends that would be greater than the bank’s undivided profits after deducting statutory bad debt in excess of the bank’s allowance for loan losses. In addition, our federal savings banks must file a notice with the OTS at least 30 days prior to paying a dividend to their parent company. Under the foregoing dividend restrictions and certain restrictions applicable to certain of our non-banking subsidiaries, as of December 31, 2006, our subsidiaries, without obtaining affirmative governmental approvals, could pay aggregate dividends of $7.9 billion to us during 2007. This amount is not necessarily indicative of amounts that may be available in future periods. In 2006, our subsidiaries paid $4.3 billion in cash dividends to us. In addition, we and our banking subsidiaries are subject to various general regulatory policies and requirements relating to the payment of dividends, including requirements to maintain adequate capital above regulatory minimums. The appropriate federal regulatory authority is authorized to determine under certain circumstances relating to the financial condition of a bank or bank holding company that the payment of dividends would be an unsafe or unsound practice and to prohibit payment thereof. The appropriate federal regulatory authorities have indicated that paying dividends that deplete a bank’s capital base to an inadequate level would be an unsafe and unsound banking practice and that banking organizations should generally pay dividends only out of current operating earnings. Source of Strength Under Federal Reserve Board policy, we are expected to act as a source of financial strength to each of our subsidiary banks and to commit resources to support each of those subsidiaries. This support may be required at times when, absent that Federal Reserve Board policy, we may not find ourselves able to provide it. Capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary banks. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment. Federal law also authorizes the Comptroller to order an assessment of Wachovia if the capital of one of our national bank subsidiaries were to become impaired. If we failed to pay the assessment within three months, the Comptroller could order the sale of our stock in the national bank to cover the deficiency. Capital Requirements Federal banking regulators have adopted risk-based capital and leverage guidelines that require that our capital-to-assets ratios meet certain minimum standards. Under the risk-based capital requirements for bank holding companies, the minimum requirement for the ratio of capital to risk-weighted assets (including certain off-balance-sheet activities, such as standby letters of credit) is 8%. At least half of the total capital (as defined below) is to be composed of common stockholders’ equity, retained earnings, qualifying perpetual preferred stock (in a limited amount in the case of cumulative preferred stock) and minority interests in the equity accounts of consolidated subsidiaries, less goodwill and certain intangibles (“tier 1 capital”). The remainder of total capital may consist of mandatory convertible debt securities and a limited amount of subordinated debt, qualifying preferred stock and loan loss allowance (“tier 2 capital”, and together with tier 1 capital, “total capital”). At December 31, 2006, our tier 1 capital and total capital ratios were 7.42% and 11.33%, respectively. In addition, the Federal Reserve Board has established minimum leverage ratio guidelines for bank holding companies. These requirements provide for a minimum leverage ratio of tier 1 capital to adjusted average quarterly assets less certain amounts (“leverage ratio”) equal to 3% for bank holding companies that meet certain specified criteria, including having the highest
regulatory rating. All other bank holding companies will generally be required to maintain a leverage ratio of at least 4%. Our leverage ratio at December 31, 2006, was 6.01%. The guidelines also provide that bank holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. Furthermore, the guidelines indicate that the Federal Reserve Board will continue to consider a “tangible tier 1 leverage ratio” (deducting all intangibles) in evaluating proposals for expansion or to engage in new activity. The Federal Reserve Board has not advised us of any specific minimum leverage ratio or tier 1 leverage ratio applicable to us. Each of our subsidiary banks is subject to similar capital requirements adopted by the Comptroller, the OTS or other applicable regulatory agency. Neither the Comptroller, the OTS nor such other applicable regulatory agency has advised any of our subsidiary banks of any specific minimum leverage ratios applicable to it. The capital ratios of our bank subsidiaries are set forth in Table 17 on page 58 in the Annual Report and incorporated herein by reference. The risk-based capital requirements identify concentrations of credit risk and certain risks arising from non-traditional activities, and the management of those risks, as important factors to consider in assessing an institution’s overall capital adequacy. Other factors taken into consideration by federal regulators include: interest rate exposure; liquidity, funding and market risk; the quality and level of earnings; the quality of loans and investments; the effectiveness of loan and investment policies; and management’s overall ability to monitor and control financial and operational risks, including the risks presented by concentrations of credit and non-traditional activities. Effective April 1, 2002, Federal Reserve Board rules govern the regulatory capital treatment of merchant banking investments and certain other equity investments, including investments made by our principal investing group, in non-financial companies held by bank holding companies. The rules generally impose a capital charge that increases incrementally as the value of the banking organization’s equity investments increase. An 8% tier 1 capital deduction would apply on covered investments that in total represent up to 15% of an organization’s tier 1 capital. For covered investments that total more than 25% of the organization’s tier 1 capital, a capital deduction of 25% would be imposed. Equity investments made through small business investment companies in an amount up to 15% of the banking organization’s tier 1 capital are exempt from the new charges, but the full amount of the equity investments are still included when calculating the aggregate value of the banking organization’s non-financial equity investments. Changes to the risk-based capital regime are frequently proposed or implemented. The minimum risk-based capital requirements adopted by the federal banking agencies follow the Capital Accord of the Basel Committee on Banking Supervision. Please see “Regulatory Matters” on page 42 in the Annual Report, incorporated herein by reference, for additional information on the Basel Committee. Bank Activities General WBNA and our other national bank subsidiaries are subject to the provisions of the National Bank Act, are under the supervision of, and subject to periodic examination by, the Comptroller, and are subject to the rules and regulations of the Comptroller, the Federal Reserve Board, and the FDIC. World Savings Bank, FSB and World Savings Bank (Texas), FSB are under the supervision of, and subject to periodic examination by, the OTS, and are subject to the rules and regulations of the OTS, the Federal Reserve Board, and the FDIC. WBNA’s operations in other countries are also subject to various restrictions imposed by the laws of those countries. In addition, all of our banks have FDIC insurance and are subject to the Federal Deposit Insurance Act (the “FDIA”). Prompt Corrective Action The FDIA, among other things, requires the federal banking agencies to take “prompt corrective action” in respect of depository institutions that do not meet minimum capital requirements. The FDIA establishes five tiers for FDIC-insured banks: (i) “well capitalized” if it has a total capital ratio of 10% or greater, a tier 1 capital ratio of 6% or greater and a leverage ratio of 5% or greater and is not subject to any order or written directive by any such regulatory authority to meet and maintain a specific capital level for any capital measure; (ii) “adequately capitalized” if it has a total capital ratio of 8% or greater, a tier 1 capital ratio of 4% or greater and a leverage ratio of 4% or greater (3% in certain circumstances) and is not “well capitalized”; (iii) “undercapitalized” if it has a total capital ratio of less than 8%, a tier 1 capital ratio of less than 4% or a leverage ratio of less than 4% (3% in certain circumstances); (iv) “significantly undercapitalized” if it has a total capital ratio of less than 6%, a tier 1 capital ratio of less than 3% or a leverage ratio of less than 3%; and (v) “critically undercapitalized” if its tangible equity is equal to or less than 2% of average quarterly tangible assets. An institution may be downgraded to, or deemed to be in, a capital category that is lower than is indicated by its capital ratios if it is determined to be in an unsafe or unsound condition or if it receives an unsatisfactory examination rating with respect to certain matters. As of December 31, 2006, all of our deposit-taking subsidiary banks had capital levels that qualify them as being “well capitalized” under those regulations.
Undercapitalized depository institutions are subject to growth limitations, the requirement to submit a capital restoration plan, and a variety of other restrictions the severity of which are keyed to the bank’s capital tier and other factors. Ultimately, critically undercapitalized institutions are subject to the appointment of a receiver or conservator. A bank that is not “well capitalized” is subject to certain limitations relating to so-called “brokered” deposits. Cross Default Each of our banks can be held liable for any loss incurred, or reasonably expected to be incurred, by the FDIC due to the default of any other of our banks, and for any assistance provided by the FDIC to any of our banks that is in danger of default and that is controlled by the same bank holding company. “Default” means generally the appointment of a conservator or receiver. “In danger of default” means generally the existence of certain conditions indicating that a default is likely to occur in the absence of regulatory assistance. An FDIC cross-guarantee claim against a bank is generally superior in right of payment to claims of the holding company and its affiliates against such depository institution. If the FDIC is appointed the conservator or receiver of an insured depository institution, upon its insolvency or in certain other events, the FDIC has the power: (i) to transfer any of the depository institution’s assets and liabilities to a new obligor without the approval of the depository institution’s creditors; (ii) to enforce the terms of the depository institution’s contracts pursuant to their terms; or (iii) to repudiate or disaffirm any contract or lease to which the depository institution is a party, the performance of which is determined by the FDIC to be burdensome and the disaffirmance or repudiation of which is determined by the FDIC to promote the orderly administration of the depository institution. Deposit Insurance The FDIC assessment rate on our subsidiary bank deposits currently is zero, but may change in the future. The FDIC may increase or decrease the assessment rate schedule on a semiannual basis. An increase in the BIF assessment rate could have a material adverse effect on our earnings, depending on the amount of the increase. The FDIC is authorized to terminate a depository bank’s deposit insurance upon a finding by the FDIC that the bank’s financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices or has violated any applicable rule, regulation, order or condition enacted or imposed by the bank’s regulatory agency. The termination of deposit insurance for one or more of our subsidiary depository banks could have a material adverse effect on our earnings, depending on the collective size of the particular institutions involved. In addition, if the ratio of insured deposits to money in the BIF drops below specified levels, the FDIC would be required to impose premiums on all banks insured by the BIF. Borrowings There are also various legal restrictions on the extent to which Wachovia and our non-bank subsidiaries can transfer funds to, or borrow or otherwise obtain credit from, our banking subsidiaries. In general, these restrictions require that any such extensions of credit must be secured by designated amounts of specified collateral and are limited, as to any one of us or those non-bank subsidiaries, to 10% of the lending bank’s capital stock and surplus, and as to us and all non-bank subsidiaries in the aggregate, to 20% of such lending bank’s capital stock and surplus. A bank’s transactions with its non-bank affiliates are also generally required to be on arm’s length terms. Depositor Preference Under federal law, deposits and certain claims for administrative expenses and employee compensation against an insured depository institution would be afforded a priority over other general unsecured claims against such an institution, including federal funds and letters of credit, in the “liquidation or other resolution” of such an institution by any receiver. As a result, whether or not the FDIC ever sought to repudiate any obligations held by public noteholders of any subsidiary of Wachovia that is an insured depository institution, the public noteholders would be treated differently from, and could receive, if anything, substantially less than, the depositors of the depository institution. Other Regulation Non-Bank Activities Our bank and certain nonbank subsidiaries are subject to direct supervision and regulation by various other federal, state and foreign authorities (many of which will be considered “functional regulators” under the Modernization Act). We also conduct securities underwriting, dealing and brokerage activities primarily through Wachovia Securities, LLC and Wachovia Capital Markets, LLC, which are subject to the regulations of the SEC, the National Association of Securities Dealers, Inc. (the “NASD”) and the NYSE. The operations of our mutual funds also are subject to regulation by the SEC. Our insurance
subsidiaries are subject to regulation by applicable state insurance regulatory agencies. The types of activities in which the foreign branches of WBNA and our international subsidiaries may engage are subject to various restrictions imposed by the Federal Reserve Board. Those foreign branches and international subsidiaries also are subject to the laws and regulatory authorities of the countries in which they operate. The Wachovia entities that are broker-dealers registered with the SEC are subject to, among other things, net capital rules designed to measure the general financial condition and liquidity of a broker-dealer. Under these rules, these entities are required to maintain the minimum net capital deemed necessary to meet broker-dealers’ continuing commitments to customers and others and required to keep a substantial portion of their assets in relatively liquid form. Broker-dealers are also subject to other regulations covering their business operations, including sales and trading practices, public offerings, publication of research reports, use and safekeeping of client funds and securities, capital structure, record-keeping and the conduct of directors, officers and employees. Broker-dealers are also subject to regulation by state securities regulators in applicable states. Violations of the regulations governing the actions of a broker-dealer can result in the revocation of broker-dealer licenses, the imposition of censures or fines, the issuance of cease and desist orders and the suspension or expulsion from the securities business of a firm, its officers or its employees. Wachovia entities engaging in our investment management activities are registered as investment advisers with the SEC, and in certain states, some employees are registered as investment adviser representatives. Recent legislative and regulatory scrutiny in the mutual fund industry has increased. This scrutiny has resulted in the adoption of new rules and a number of legislative and regulatory proposals, including SEC rules designed to strengthen existing prohibitions relating to late trading and enhance required disclosure and supervision of market timing policies and pricing and mutual fund sales practices. Our subsidiaries acting as consumer lenders also are subject to regulation under various federal laws, including the Truth-inLending, the Equal Credit Opportunity, the Fair Credit Reporting, the Fair Debt Collection Practice and the Electronic Funds Transfer Acts, as well as various state laws. These statutes impose requirements on the making, enforcement and collection of consumer loans and on the types of disclosures that need to be made in connection with such loans. International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 The President signed the USA Patriot Act of 2001 into law in October 2001. This act contains the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 (the “IMLAFA”). The IMLAFA substantially broadens existing anti-money laundering legislation and the extraterritorial jurisdiction of the United States, imposes new compliance and due diligence obligations, creates new crimes and penalties, compels the production of documents located both inside and outside the United States, including those of foreign institutions that have a correspondent relationship in the United States, and clarifies the safe harbor from civil liability to customers. The U.S. Treasury Department has issued a number of regulations implementing the USA Patriot Act that apply certain of its requirements to financial institutions such as our banking and brokerdealer subsidiaries. The regulations impose new obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing. The increased obligations of financial institutions, including Wachovia, to identify their customers, watch for and report suspicious transactions, respond to requests for information by regulatory authorities and law enforcement agencies, and share information with other financial institutions, requires the implementation and maintenance of internal procedures, practices and controls which have increased, and may continue to increase, our costs and may subject us to liability. Pursuant to the IMLAFA, Wachovia established anti-money laundering compliance and due diligence programs which include, among other things, the designation of a compliance officer, employee training programs, and an independent audit function to review and test the program. As noted above, enforcement and compliance-related activity by government agencies has increased. Money laundering and anti-terrorism compliance is among the areas receiving a high level of focus in the present environment. Privacy Under the Modernization Act, federal banking regulators adopted rules limiting the ability of banks and other financial institutions to disclose nonpublic information about consumers to nonaffiliated third parties. The rules require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to nonaffiliated third parties. The privacy provisions of the Modernization Act affect how consumer information is transmitted through diversified financial services companies and conveyed to outside vendors. Future Legislation Changes to the laws and regulations (including changes in interpretation or enforcement) in the states and countries where we and our subsidiaries do business can affect the operating environment of bank holding companies and their subsidiaries in
substantial and unpredictable ways. From time to time, various legislative and regulatory proposals are introduced. These proposals, if codified, may change banking statutes and regulations and our operating environment in substantial and unpredictable ways. If codified, these proposals could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions and other financial institutions. We cannot accurately predict whether those changes in laws and regulations will occur, and, if those changes occur, the ultimate effect they would have upon our financial condition or results of operations. It is likely, however, that the current high level of enforcement and compliance-related activities of federal and state authorities will continue and potentially increase. Additional Information Additional information related to certain accounting and regulatory matters is set forth on pages 16 through 19, and on pages 40 through 42 in the Annual Report and incorporated herein by reference.
ITEM 1A.
RISK FACTORS.
An investment in Wachovia’s securities may involve risks due to the nature of the businesses we engage in and activities related to those businesses. The following are the most significant risks associated with those businesses or activities: Business risk. Wachovia’s business model is based on a diversified mix of businesses that provide a broad range of financial products and services, delivered through multiple distribution channels. Wachovia’s diversified businesses are subject to a wide range of competition, ranging from smaller community banking institutions, financial advisors and investment advisors to large, diversified, multi-national financial services providers. Risks associated with our business model include: • • • • • • the timely development of competitive new products and services by Wachovia and the acceptance of these products and services by new and existing customers; the willingness of customers to accept third party products marketed by Wachovia; the willingness of customers to substitute competitors’ products and services for Wachovia’s products and services and vice versa; the impact of changes in financial services’ laws and regulations (including laws concerning taxes, banking, securities and insurance); technological changes; and changes in consumer spending and saving habits.
Credit risk. Wachovia is one of the nation’s largest lenders, and the credit quality of our portfolio can have a significant impact on our earnings. Credit risk is the risk of loss due to adverse changes in a borrower’s ability to meet its financial obligations under agreed upon terms. Risks associated with our credit quality include: • the strength of the United States economy in general and the strength of the local economies in which Wachovia conducts operations may be different than expected resulting in, among other things, a deterioration in credit quality or a reduced demand for credit, including the resultant effect on Wachovia’s loan portfolio and allowance for loan losses; and adverse changes in the financial performance and/or condition of Wachovia’s borrowers which could impact repayment of such borrowers’ outstanding loans.
•
Market risk. Wachovia’s businesses are subject to market risk. The components of market risk are interest rate risk inherent in our balance sheet, price risk in our principal investing portfolio and market value risk in our trading portfolios. Risks associated with managing market risk include: • • • the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Federal Reserve Board; inflation, interest rate, market and monetary fluctuations; and adverse conditions in the stock market, the public debt market and other capital markets (including changes in interest rate conditions) and the impact of such conditions on Wachovia’s capital markets and capital management activities, including, without limitation, Wachovia’s mergers and acquisition advisory business, equity and debt underwriting activities, private equity investment activities, derivative securities activities, investment and wealth management advisory businesses, and brokerage activities.
Operational risk. Operational risk is the risk of loss from inadequate or failed internal processes, people and systems or from external events. Risks associated with operational risk include:
• • • • •
unanticipated regulatory or judicial proceedings or rulings; matters impacting our business or ethical reputation; the impact of changes in accounting principles; the impact on Wachovia’s businesses of various domestic or international military or terrorist activities or conflicts; and Wachovia’s success at managing all of these risks.
Acquisitions and divestitures. When consistent with our overall business strategy, we may consider disposing of certain assets, branches, subsidiaries or lines of business. We continue to routinely explore acquisition opportunities in areas that would complement our core businesses, and frequently conduct due diligence activities in connection with possible acquisitions. As a result, acquisition discussions and, in some cases, negotiations frequently take place and future acquisitions involving cash, debt or equity securities could occur. In the event Wachovia engages in acquisitions or divestitures, there are risks involved. Risks associated with acquisitions and divestitures include: • • • • the risk that the businesses proposed to be acquired or divested will not be integrated successfully or such integration may be more difficult, time-consuming or costly than expected; the risk that expected revenue synergies and cost savings from the businesses proposed to be acquired may not be fully realized or realized within the expected time frames; the risk that revenues following the proposed acquisition may be lower than expected; and the risk that deposit attrition, operating costs, customer loss and business disruption following the proposed acquisition, including, without limitation, difficulties in maintaining relationships with employees, may be greater than expected.
ITEM 1B. None.
UNRESOLVED STAFF COMMENTS.
ITEM 2.
PROPERTIES.
As of December 31, 2006, we and our subsidiaries owned 2,057 locations and leased 4,324 locations in 48 states, Washington, D.C., Puerto Rico and 35 foreign countries from which our business is conducted, including a multi-building office complex in Charlotte, North Carolina, which serves as Wachovia’s administrative headquarters, as well as the headquarters of WBNA, Wachovia Mortgage Corporation, Wachovia Capital Markets, LLC, World Savings Bank, FSB and most of our non-banking subsidiaries. That multi-office complex is used as administrative headquarters for our General Bank, Corporate and Investment Bank, Capital Management and the Parent segments as identified in our Annual Report. Wachovia’s Wealth Management segment, as identified in our Annual Report, has its principal administrative offices in a multi-office complex in Winston-Salem, North Carolina. Some of our non-banking subsidiaries have principal administrative offices in other cities in the United States. The principal administrative offices of our retail securities brokerage operations are in Richmond, Virginia. The principal administrative offices of our mutual fund operations are in Boston, Massachusetts. Certain of our institutional securities operations are conducted in offices in New York, New York. Certain of the administrative functions for World Savings Bank, FSB are conducted in offices in Oakland, California. The vast majority of our leased and owned properties are used for our branch banking operations and retail securities brokerage offices. Additional information relating to our lease commitments is set forth in Note 20 on page 120 in the Annual Report and incorporated herein by reference.
ITEM 3.
LEGAL PROCEEDINGS.
Wachovia and certain of our subsidiaries are involved in a number of judicial, regulatory and arbitration proceedings concerning matters arising from the conduct of our business activities. These proceedings include actions brought against Wachovia and/or its subsidiaries with respect to transactions in which Wachovia and/or our subsidiaries acted as banker, lender, underwriter, financial advisor or broker or in activities related thereto. In addition, Wachovia and its subsidiaries may be requested to provide information or otherwise cooperate with governmental authorities in the conduct of investigations of other persons or industry groups. It is Wachovia’s policy to cooperate in all regulatory inquiries and investigations. Although there can be no assurance as to the ultimate outcome, Wachovia and/or our subsidiaries have generally denied, or believe we have a meritorious defense and will deny, liability in all significant litigation pending against us, including the matters described below, and we intend to defend vigorously each such case. Reserves are established for legal claims when payments associated with the claims become probable and the costs can be reasonably estimated. The actual costs of resolving legal claims may be substantially higher or lower than the amounts reserved for those claims.
In the Matter of KPMG LLP Certain Auditor Independence Issues. The SEC has requested Wachovia to produce certain information concerning any agreements or understandings by which Wachovia referred clients to KPMG LLP during the period January 1, 1997 to November 2003 in connection with an inquiry regarding the independence of KPMG LLP as Wachovia’s outside auditors during such period. Wachovia is continuing to cooperate with the SEC in its inquiry, which is being conducted pursuant to a formal order of investigation entered by the SEC on October 21, 2003. Wachovia believes the SEC’s inquiry relates to certain tax services offered to Wachovia customers by KPMG LLP during the period from 1997 to early 2002, and whether these activities might have caused KPMG LLP not to be “independent” from Wachovia, as defined by applicable accounting and SEC regulations requiring auditors of an SEC-reporting company to be independent of the company. Wachovia and/or KPMG LLP received fees in connection with a small number of personal financial consulting transactions related to these services. KPMG LLP has confirmed to Wachovia that during all periods covered by the SEC’s inquiry, including the present, KPMG LLP was and is “independent” from Wachovia under applicable accounting and SEC regulations. Financial Advisor Wage/Hour Class Action Litigation. Wachovia Securities, LLC, Wachovia’s retail securities brokerage subsidiary, is a defendant in multiple state and nationwide putative class actions alleging unpaid overtime wages and improper wage deductions for financial advisors. In December 2006 and January 2007, related cases pending in U.S. District courts in several states were consolidated for case administrative purposes in the U.S. District Court for the Central District of California pursuant to two orders of the Multi-District Litigation Panel. There is an additional case alleging a statewide class under California law, which is currently pending before the California Court of Appeals. Wachovia believes that it has meritorious defenses to the claims asserted in these lawsuits, which are part of an industry trend of related wage/hour class action litigation, and intends to defend vigorously the cases. Adelphia Litigation. Certain Wachovia affiliates are defendants in an adversary proceeding previously pending in the United States Bankruptcy Court for the Southern District of New York related to the bankruptcy of Adelphia Communications Corporation (“Adelphia”). In February 2006, an order was entered moving the case to the United States District Court for the Southern District of New York. The Official Committee of Unsecured Creditors in Adelphia’s bankruptcy case has filed claims on behalf of Adelphia against over 300 financial services companies, including the Wachovia affiliates. The complaint asserts claims against the defendants under state law, bankruptcy law and the Bank Holding Company Act and seeks equitable relief and an unspecified amount of compensatory and punitive damages. The Official Committee of Equity Security Holders has sought leave to intervene in that complaint and sought leave to bring additional claims against certain of the financial services companies, including the Wachovia affiliates, including additional federal and state claims. On August 30, 2005, the bankruptcy court granted the creditors’ committee and the equity holders’ committee standing to proceed with their claims. Wachovia and other defendants have filed motions to dismiss the complaints. In addition, certain affiliates of Wachovia, together with numerous other financial services companies, have been named in several private civil actions by investors in Adelphia debt and/or equity securities, alleging among other claims, misstatements in connection with Adelphia securities offerings between 1997 and 2001. Wachovia affiliates acted as an underwriter in certain of those securities offerings, as agent and/or lender for certain Adelphia credit facilities, and as a provider of Adelphia’s treasury/cash management services. These complaints, which seek unspecified damages, have been consolidated in the United States District Court for the Southern District of New York. In separate orders entered in May and July 2005, the District Court dismissed a number of the securities law claims asserted against Wachovia, leaving some securities law claims pending. Wachovia still has a pending motion to dismiss with respect to these claims. On June 15, 2006, the District Court signed the preliminary order with respect to a proposed settlement of the securities class action pending against Wachovia and the other financial services companies. At a fairness hearing on the settlement on November 10, 2006, the District Court approved the settlement. Wachovia’s share of the settlement, $1.173 million, was paid in November 2006. The other private civil actions have not been settled. Other Regulatory Matters. Governmental and self-regulatory authorities have instituted numerous ongoing investigations of various practices in the securities and mutual fund industries, including those discussed in Wachovia’s previous filings with the SEC and those relating to market-timing, sales practices and record retention. The investigations cover advisory companies to mutual funds, broker-dealers, hedge funds and others. Wachovia has received subpoenas and other requests for documents and testimony relating to the investigations, is endeavoring to comply with those requests, is cooperating with the investigations, and where appropriate, is engaging in discussions to resolve the investigations. Wachovia is continuing its own internal review of policies, practices, procedures and personnel, and is taking remedial action where appropriate. In connection with one of these investigations, on July 28, 2004, the SEC staff advised Wachovia’s investment advisory subsidiary that the staff is considering recommending to the SEC that it institute an enforcement action against the investment advisory subsidiary, Evergreen Investment Management Company, LLC, and other Evergreen entities. The SEC staff’s proposed allegations relate to (i) an arrangement involving a former Evergreen employee and an individual broker pursuant to which the broker, on behalf of a client, made exchanges to and from a mutual fund during the period December 2000 through April 2003 in excess of the limitations set forth in the mutual fund prospectus, (ii) purchase and sale activity from September 2001 through January 2003 by a former Evergreen portfolio manager in the mutual fund he managed at the time, (iii) the sufficiency of systems for monitoring exchanges and enforcing exchange limitations stated in mutual fund prospectuses, and (iv)
the adequacy of e-mail retention practices. In addition, on September 17, 2004, the SEC staff advised Wachovia Securities that the staff is considering recommending to the SEC that it institute an enforcement action against the brokerage subsidiary regarding the allegations described in (i) of the preceding sentence. Wachovia currently is engaged in discussions with the SEC staff regarding the matters described in (i) through (iv) above. Wachovia intends to make a written Wells submission, if it is unable to satisfactorily resolve these matters, explaining why Wachovia believes enforcement action should not be instituted. Outlook. Based on information currently available, advice of counsel, available insurance coverage and established reserves, Wachovia believes that the eventual outcome of the actions against Wachovia and/or its subsidiaries, including the matters described above, will not, individually or in the aggregate, have a material adverse effect on Wachovia’s consolidated financial position or results of operations. However, in the event of unexpected future developments, it is possible that the ultimate resolution of those matters, if unfavorable, may be material to Wachovia’s results of operations for any particular period.
Disclosure of Tax Shelter Penalties Not applicable.
ITEM 4. None.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
PART II ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Our common stock is listed on the NYSE. Table 6 on page 49 in the Annual Report sets forth information relating to the quarterly prices of, and quarterly dividends paid on, the common stock for the two-year period ended December 31, 2006, and incorporated herein by reference. Prices shown represent the high, low and quarter-end sale prices of the common stock as reported on the NYSE Composite Transactions tape for the periods indicated. As of December 31, 2006, there were 173,486 holders of record of the common stock. In connection with the merger with Legacy Wachovia, holders of shares of Legacy Wachovia common stock elected to receive, in addition to 2 shares of Wachovia common stock, either a one-time $0.48 cash payment or 2 shares of a new class of Wachovia preferred stock. At December 31, 2006, 96,536,312 Wachovia Dividend Equalization Preferred shares (“DEPs”) were outstanding. Because Wachovia paid common stock dividends equal to $1.25 per share in the four quarters of 2003, holders of DEPs are no longer entitled to receive any dividend on the DEPs and Wachovia has ceased to pay any such dividends. The DEPs are not listed on a national securities exchange and have no voting rights. Subject to the prior rights of holders of any outstanding shares of our preferred stock or Class A preferred stock, holders of common stock are entitled to receive such dividends as may be legally declared by our board of directors and, in the event of dissolution and liquidation, to receive our net assets remaining after payment of all liabilities, in proportion to their respective holdings. Additional information concerning certain limitations on our payment of dividends is set forth above under “Business -- Supervision and Regulation; Payment of Dividends” and in Note 22 on page 127 in the Annual Report and incorporated herein by reference. Under our Shareholder Protection Rights Agreement, each outstanding common stock share has a right attached to it. This right remains attached unless a separation time occurs. At separation time, common shareholders will receive separate certificates for these rights. Each right entitles its owner to purchase at separation time one one-hundredth of a share of a participating series of Class A preferred stock for $105. This series of Class A preferred stock would have economic and voting terms similar to those of one common stock share. Separation time would generally occur at the earlier of the following two dates: • • the tenth business day after any person commences a tender or exchange offer that entitles that person to 10% or more of our outstanding common stock, or the tenth business day after we publicly announce that a person has acquired beneficial ownership of 10% or more of our outstanding common stock.
These rights will not trade separately from the shares of common stock until a separation time occurs, and may be exercised on the business day immediately after the separation time. The rights will expire at the earliest of:
• • •
the date on which our board of directors elects to exchange the rights for our common stock or preferred stock as described below; the close of business on December 28, 2010, unless our board of directors extends that time; or the date on which the rights are terminated as described below.
Once we publicly announce that a person has acquired 10% of our outstanding common stock, we can allow for rights holders to buy our common stock for half of its market value. For example, we would sell to each rights holder common stock shares worth $210 for $105 in cash. At the same time, any rights held by the 10% owner or any of its affiliates, associates or transferees will be void. In addition, if we are acquired in a merger or other business combination after a person has become a 10% owner, the rights held by shareholders would become exercisable to purchase the acquiring company’s common stock for half of its market value. In the alternative, our board of directors may elect to exchange all of the then outstanding rights for shares of common stock at an exchange ratio of two common stock shares for one right. Upon election of this exchange, a right will no longer be exercisable and will only represent a right to receive two common stock shares. If we are required to issue common stock shares upon the exercise of rights, or in exchange for rights, our board of directors may substitute shares of participating Class A preferred stock. The substitution will be at a rate of two one one-hundredths of a share of participating Class A preferred stock for each right exchanged. The rights may be terminated without any payment to holders before their exercise date. The rights have no voting rights and are not entitled to dividends. The rights will not prevent a takeover of Wachovia. The rights, however, may cause substantial dilution to a person or group that acquires 10% or more of our common stock unless our board first terminates the rights. Nevertheless, the rights should not interfere with a transaction that is in Wachovia’s and its shareholders’ best interests because the board can terminate the rights before that transaction is completed. The complete terms of the rights are contained in the Shareholder Protection Rights Agreement. The foregoing description of the rights and the rights agreement is qualified in its entirety by reference to the agreement. A copy of the rights agreement can be obtained upon written request to Wachovia Bank, National Association, 301 South College Street, Charlotte, North Carolina 28288-0206. Additional information relating to our common stock and the DEPs is set forth in Note 12 on pages 96 through 98 in the Annual Report and incorporated herein by reference. Purchases of Equity Securities by the Issuer and Affiliated Purchasers. In January 2004, our board of directors authorized the repurchase of 60 million shares of our common stock, which together with remaining authority from previous board authorizations in 1999 and 2000, permitted Wachovia to repurchase up to 123 million shares of our common stock as of January 15, 2004, the date that authorization was announced. In addition, on August 16, 2005, Wachovia announced that our board of directors authorized the repurchase of an additional 100 million shares of our common stock. Future stock repurchases may be private or open-market purchases, including block transactions, accelerated or delayed block transactions, forward transactions, collar transactions, and similar transactions. The amount and timing of stock repurchases will be based on various factors, such as management’s assessment of Wachovia’s capital structure and liquidity, the market price of Wachovia common stock compared to management’s assessment of the stock’s underlying value, and applicable regulatory, legal and accounting factors. In 2006, Wachovia repurchased 82 million shares of Wachovia common stock, all but 3.3 million of such repurchases were in the open market, at an average cost of $54.96 per share. Please see “Stockholders’ Equity” on page 31 in the Annual Report for additional information about Wachovia’s share repurchases in 2006. The following table sets forth information about our stock repurchases for the three months ended December 31, 2006. Issuer Repurchases of Equity Securities
Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs (3) 42,563,415
Period (1) October 1, 2006 to October 31,
Total Number of Shares Purchased (2) 6,000,000
Average Price Paid per Share $55.29
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (3) 6,000,000
2006 November 1, to November 2006 December 1, to December 2006 Total
2006 30, 1,050,000 2006 31, -7,050,000 -55.22 -7,050,000 41,513,415 41,513,415 54.84 1,050,000 41,513,415
___________ (1) Based on trade date, not settlement date. (2) All of these shares were repurchased pursuant to publicly announced share repurchase programs. The nature of these repurchases were as follows: October 2006 – open market repurchases: 6,000,000 shares; and November 2006 – open market repurchases: 1,050,000 shares. In addition to these repurchases, pursuant to Wachovia’s employee stock option plans, participants may exercise Wachovia stock options by surrendering shares of Wachovia common stock the participants already own as payment of the option exercise price. Shares so surrendered by participants in Wachovia’s employee stock option plans are repurchased pursuant to the terms of the applicable stock option plan and not pursuant to publicly announced share repurchase programs. For the quarter ended December 31, 2006, the following shares of Wachovia common stock were surrendered by participants in Wachovia’s employee stock option plans: October 2006 – 20,621 shares at an average price per share of $55.31; November 2006 – 9,528 shares at an average price per share of $55.43; and December 2006 – 24,697 shares at an average price per share of $55.98. (3) On May 25, 1999, Wachovia announced a stock repurchase program pursuant to which Wachovia was authorized to repurchase up to 50 million shares of its common stock. On June 26, 2000, Wachovia announced a stock repurchase program pursuant to which Wachovia was authorized to repurchase up to 50 million shares of its common stock. On January 15, 2004, Wachovia announced a stock repurchase program pursuant to which Wachovia was authorized to repurchase up to 60 million shares of its common stock. On August 16, 2005, Wachovia announced a stock repurchase program pursuant to which Wachovia was authorized to repurchase up to 100 million shares of its common stock. None of these programs has an expiration date and each respective program expires upon completion of repurchases totaling the amount authorized for repurchase. During the second quarter of 2004, all remaining shares authorized under the May 1999 authorization, which totaled approximately 5.2 million shares at the beginning of the quarter, were repurchased. During the first quarter of 2005, all remaining shares authorized under the June 2000 authorization, which totaled approximately 15.7 million shares at the beginning of the quarter, were repurchased. During the first quarter of 2006, all remaining shares authorized under the January 2004 authorization, which totaled approximately 23.6 million shares at the beginning of the quarter, were repurchased. As of December 31, 2006, there are no more shares remaining under the May 1999, June 2000 and January 2004 authorizations, and approximately 41.5 million shares remaining under the August 2005 authorization. Performance Graph In response to this Item, the information set forth in the table on page 2 in the Annual Report under the caption “Total Return 2001-2006” and in Table 2 on page 46 in the Annual Report under the caption “Total Return Performance” is incorporated herein by reference.
ITEM 6.
SELECTED FINANCIAL DATA.
In response to this Item, the information set forth in Table 3 on page 47 in the Annual Report is incorporated herein by reference.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
In response to this Item, the information set forth on pages 14 through 61 in the Annual Report is incorporated herein by reference.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
In response to this Item, the information set forth on pages 33 through 39 and in Note 4 on page 81, in Note 19 on page 112, and in Note 20 on page 120 in the Annual Report is incorporated herein by reference.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
In response to this Item, the information set forth in Table 6 on page 49 and on pages 62 through 129 in the Annual Report is incorporated herein by reference.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
ITEM 9A.
CONTROLS AND PROCEDURES.
Evaluation of Disclosure Controls and Procedures. As of December 31, 2006, the end of the period covered by this Annual Report on Form 10-K, Wachovia’s management, including Wachovia’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, Wachovia’s Chief Executive Officer and Chief Financial Officer each concluded that as of December 31, 2006, the end of the period covered by this Annual Report on Form 10-K, Wachovia maintained effective disclosure controls and procedures. Management’s Report on Internal Control over Financial Reporting. Wachovia’s management is responsible for establishing and maintaining effective internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934). Wachovia’s internal control over financial reporting is under the general oversight of the Board of Directors acting through the Audit Committee, which is composed entirely of independent directors. KPMG LLP, Wachovia’s independent auditors, has direct and unrestricted access to the Audit Committee at all times, with no members of management present, to discuss its audit and any other matters that have come to its attention that may affect Wachovia’s accounting, financial reporting or internal controls. The Audit Committee meets periodically with management, internal auditors and KPMG LLP to determine that each is fulfilling its responsibilities and to support actions to identify, measure and control risk and augment internal control over financial reporting. Internal control over financial reporting, however, cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Under the supervision and with the participation of management, including Wachovia’s Chief Executive Officer and Chief Financial Officer, Wachovia conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2006 based on the framework in “Internal Control – Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based upon that evaluation, management concluded that our internal control over financial reporting was effective as of December 31, 2006. Management’s report on internal control over financial reporting is set forth on page 62 in Wachovia’s 2006 Annual Report, which is included as Exhibit (13) to this Annual Report on Form 10-K, and is incorporated herein by reference. Management’s assessment of the effectiveness of Wachovia’s internal control over financial reporting has been audited by KPMG LLP, an independent, registered public accounting firm, as stated in its report, which is set forth on page 63 in Wachovia’s 2006 Annual Report and is incorporated herein by reference. Changes in Internal Control Over Financial Reporting. No change in our internal control over financial reporting occurred during the fourth quarter of our fiscal year ended December 31, 2006, that has materially affected, or is reasonably likely to materially affect, Wachovia’s internal control over financial reporting.
ITEM 9B. None.
OTHER INFORMATION.
PART III ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
Our executive officers are generally elected to their offices for one-year terms at the board of directors meeting in April of each year. The terms of any executive officers elected after that date expire at the same time as the terms of the executive officers elected on that date. The names of each of our current executive officers, their ages, their positions with us, and, if different, their business experience during the past five years, are as follows: G. Kennedy Thompson (56). Chairman, since February 2003, Chief Executive Officer, and President. Also Chairman, from
March 2001 to September 2001. Also, a director of Wachovia. David M. Carroll (49). Senior Executive Vice President, since September 2001. Stephen E. Cummings (51). Senior Executive Vice President, since February 2002. Previously, Senior Vice President of Wachovia Securities, Inc. (formerly named First Union Securities, Inc.) and Co-Head, Corporate and Investment Bank, from January 2000 to February 2002. Gerald A. Enos, Jr. (47). Senior Executive Vice President, since April 2006. Previously, Executive Vice President, Head of Operations, from August 2005 to March 2006, and Executive Vice President, Head of Enterprise Support Services from September 2001 to July 2005. Benjamin P. Jenkins, III (62). Vice Chairman, since December 2005. Previously, Senior Executive Vice President, from September 2001 to December 2005. Stanhope A. Kelly (49). Senior Executive Vice President, since September 2001. Shannon W. McFayden (46). Senior Executive Vice President, since February 2004. Previously, Executive Vice President, Director Community Affairs, from December 2003 to February 2004, and Senior Vice President, Director of Community Affairs, from September 2001 to December 2003. Mark C. Treanor (60). Senior Executive Vice President, Secretary and General Counsel, since September 2001. Donald K. Truslow (48). Senior Executive Vice President, since September 2001. Thomas J. Wurtz (44). Senior Executive Vice President and Chief Financial Officer, since January 2006. Previously, Executive Vice President and Treasurer, from October 2002 to January 2006, and Senior Vice President and Treasurer prior to October 2002. Wallace D. Malone, Jr. was Vice Chairman and a director of Wachovia prior to his retirement in January 2006. Robert P. Kelly was Senior Executive Vice President and Chief Financial Officer prior to terminating his employment with Wachovia in February 2006. Jean E. Davis was Senior Executive Vice President prior to her retirement in May 2006. In addition to the foregoing, the information set forth in the Proxy Statement under the headings “General Information and Nominees”, “Board Matters – Committee Structure; Audit Committee”, “Corporate Governance Policies and Practices – Code of Conduct & Ethics”, and under the subheading “Section 16(a) Beneficial Ownership Reporting Compliance” under the heading “Other Matters Relating to Executive Officers and Directors and Related Party Transactions Policy” is incorporated herein by reference.
ITEM 11.
EXECUTIVE COMPENSATION.
In response to this Item, the information set forth in the Proxy Statement under the headings “Corporate Governance Policies and Practices – Compensation of Directors”, “Executive Compensation”, “Compensation Discussion & Analysis”, “Compensation Committee Interlocks and Insider Participation”, and “Compensation Committee Report” is incorporated herein by reference.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
In response to this Item, the information set forth in the Proxy Statement relating to the ownership of common stock and DEPs by our directors, executive officers and principal stockholders under the headings “Security Ownership of Management” and “Security Ownership of Certain Beneficial Owners”, is incorporated herein by reference. In addition, set forth below is certain information relating to securities authorized for issuance under our equity compensation plans and a description of material features of equity compensation plans not approved by stockholders. Additional Information Regarding Wachovia’s Equity Compensation Plans We maintain several equity compensation plans. Our current primary plan is the Amended and Restated Wachovia Corporation 2003 Stock Incentive Plan, which is used for stock awards to our executive officers as well as other key employees. Our shareholders approved the 2003 Plan at our 2003 annual shareholders’ meeting and approved the Amended and Restated 2003 Plan at a special shareholders’ meeting in August 2006. The 2003 Plan is the only plan Wachovia currently uses to make stock compensation awards. Prior to adopting the 2003 Plan, Wachovia utilized some equity compensation plans that were approved
by our stockholders and some equity compensation plans that were not required to be approved by our stockholders. One such plan, named the Wachovia Stock Plan and referred to herein as the “Legacy Wachovia Stock Plan”, was approved by Legacy Wachovia stockholders in 1994. See “Material Features of Stock Plans Not Approved by Stockholders” below. The following table gives information as of December 31, 2006 with respect to shares of our common stock that may be issued under existing stock incentive plans. The table does not include information with respect to shares subject to outstanding options granted under certain stock incentive plans assumed by Wachovia in connection with mergers and acquisitions of companies that originally granted those options, including Golden West and Westcorp. Footnote (5) to the table indicates the total number of shares of common stock issuable upon the exercise of options under the assumed plans as of December 31, 2006, and the weighted average exercise price of those options. No additional options may be granted under those assumed plans. EQUITY COMPENSATION PLAN INFORMATION
(a) (b) (c) Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) (1)
Plan category
Number of securities to be issued upon exercise of outstanding options, warrants and rights
Weighted-average exercise price of outstanding options, warrants and rights
Equity compensation plans approved by stockholders (2) Equity compensation plans not approved by stockholders (4) Total
91,743,277 8,391,750 100,135,027
$44.01 $35.95 $43.33
116,367,892(3) 0 116,367,892
(1) Following adoption of the 2003 Stock Incentive Plan, Wachovia will not issue any future awards from any stock compensation plans other than the 2003 Plan. The 2003 Plan contains a provision that enables Wachovia to make new stock awards under the 2003 Plan equal to the number of forfeited, cancelled, terminated, expired or lapsed stock awards granted under any Wachovia stock plan. For purposes of completing this table, Wachovia has assumed that none of such forfeitures, cancellations, terminations, expirations or lapses will occur. The securities remaining available for future issuance set forth in column (c) under the 2003 Plan may be in the form of • • • stock options, stock appreciation rights, or stock awards, including restricted stock awards, restricted stock units, performance stock awards, performance stock units or other awards based on or with a value tied to, shares of Wachovia common stock.
(2) Consists of (A) the 2003 Plan which is currently in effect, and (B) Wachovia’s 1998 Stock Incentive Plan and 1996 Master Stock Compensation Plan, each of which was approved by stockholders; however, following adoption of the 2003 Plan, Wachovia cannot make new stock awards under these other plans. As of December 31, 2006, a total of 37,486,588 shares of Wachovia common stock were issuable upon the exercise of outstanding options under the plans set forth in (B) of the preceding sentence and the weighted average exercise price of those outstanding options is $39.90 per share. (3) Represents only shares available for issuance under the 2003 Plan. (4) Consists of the 2001 Stock Incentive Plan, the Employee Retention Stock Plan and the Legacy Wachovia Stock Plan, each discussed below under “Material Features of Stock Plans Not Approved by Stockholders”. (5) The table does not include information for stock incentive plans Wachovia assumed in connection with mergers and acquisitions of the companies that originally established those plans, except for the Legacy Wachovia Stock Plan. As of December 31, 2006, a total of 37,562,393 shares of common stock were issuable upon exercise of outstanding options under those assumed plans. The weighted average exercise price of those outstanding options is $30.62 per share. No additional options may be granted under those assumed plans. Material Features of Stock Plans Not Approved by Stockholders The following is a brief summary of Wachovia’s stock compensation plans that have not been approved by stockholders. Those plans are the 2001 Stock Incentive Plan, the Employee Retention Stock Plan and the Legacy Wachovia Stock Plan. Wachovia issued stock awards under these plans prior to adoption of the 2003 Plan. Wachovia will not issue any future stock awards from any of these plans. Our Management Resources & Compensation Committee of Wachovia’s board of directors administers all of these plans and has authority to make all decisions regarding these plans. These plans share the same general features, except as may be set forth in more detail below.
General. The plans provide for the grant of options and stock awards, including restricted stock awards, to nonexecutive officer employees. The number of shares available for previously issued but unexercised options is subject to adjustment for any future stock dividends, splits, mergers, combinations or other capitalization changes. In the event of a change in control of Wachovia, all outstanding awards under the plans will be immediately exercisable and/or fully vested, as the case may be. The Legacy Wachovia board and stockholders adopted the Legacy Wachovia Stock Plan in April 1994. The Legacy Wachovia Stock Plan was further amended and restated effective April 2002 by Wachovia following the merger between Legacy First Union and Legacy Wachovia. Legacy First Union’s board of directors adopted the 2001 Stock Incentive Plan in July 2001 and adopted the Employee Retention Stock Plan in April 2000. Options. Each option granted under the plans is evidenced by a written award agreement that specifies the type of option granted, the option exercise price, the option duration, the vesting date(s) and the number of shares of common stock subject to the option. No option granted under the plans has an option exercise price that is less than the fair market value of the common stock on the option grant date. No option will be exercisable later than the tenth anniversary date of its grant. Payment of the option price upon exercise may be made (i) in cash, (ii) by tendering shares of previously owned common stock having a fair market value at the time of exercise equal to the total option exercise price, (iii) cashless exercise through a broker, or (iv) by a combination of the foregoing. 2001 Stock Incentive Plan and Employee Retention Plan. Unless the compensation committee determines otherwise, in the event the employment of a participant is terminated by reason of death, disability or retirement, any outstanding options will become immediately exercisable at any time prior to the earlier of the expiration date of the options or within three years after employment ceases. If the employment of the participant terminates for any other reason, unless the compensation committee determines otherwise, the rights under any then outstanding and unexercisable options will be forfeited and the rights under any then outstanding and exercisable options will be forfeited upon the earlier of the option expiration date or three months after the day employment ends. Legacy Wachovia Stock Plan. Unless the compensation committee determines otherwise, in the event the employment of a participant is terminated by reason of displacement, death, disability or retirement, any outstanding options will become immediately exercisable at any time prior to the earlier of the expiration date of the options or within a certain period after employment ceases, depending on the date of option grant. If the employment of the participant terminates for any other reason, unless the compensation committee determines otherwise, the rights under any then outstanding and unexercisable options will be forfeited and the rights under any then outstanding and exercisable options will be forfeited upon the earlier of the option expiration date or three months after the day employment ends. Stock Awards. During the period of restriction, participants holding shares of restricted stock may exercise full voting rights and be entitled to receive all dividends and other distributions paid with respect to those shares while they are so held. If any such dividends or distributions are paid in shares of common stock, the shares will be subject to the same restrictions on transferability as the shares of restricted stock with respect to which they were paid. Under the Legacy Wachovia Stock Plan, if the stock awards are in the form of restricted stock units, the participant will not have voting rights with respect to those restricted units and may receive dividend equivalent rights if provided in the applicable award agreement. 2001 Stock Incentive Plan and Employee Retention Plan. Unless the compensation committee determines otherwise, in the event that a participant terminates employment because of normal retirement, death or disability, any remaining period of restriction applicable to the stock award will terminate automatically. Unless the compensation committee determines otherwise, if the employment of a participant terminates for any reason other than death, disability or normal retirement, then any stock awards subject to restrictions on the date of such termination will automatically be forfeited on the day employment terminates; provided, however, if employment terminates due to early retirement or any involuntary termination by Wachovia, the compensation committee may, in its sole discretion, waive the automatic forfeiture of any or all such stock awards and/or may add such new restrictions to such stock awards as it deems appropriate. Legacy Wachovia Stock Plan. Unless the compensation committee determines otherwise, in the event that a participant terminates employment because of displacement, retirement, death or disability, any remaining period of restriction applicable to the stock award terminates automatically. Unless the compensation committee determines otherwise, if the employment of a participant terminates for any reason other than death, disability or normal retirement, then any stock awards subject to restrictions on the date of such termination will automatically be forfeited on the day employment terminates; provided, however, if employment terminates due to early retirement or any involuntary termination by Wachovia, the compensation committee may, in its sole discretion, waive the automatic forfeiture of any or all such stock awards and/or may add such new restrictions to such stock awards as it deems appropriate. Except as may otherwise be provided in the Legacy Wachovia Stock Plan or as the compensation committee otherwise determines, in the event that a participant terminates employment with Wachovia for any reason other than as set forth above, or for
any reason provided for in the terms of the grant, then any shares of restricted stock still subject to restrictions at the date of such termination shall automatically be forfeited. SARs. The Employee Retention Stock Plan and the Legacy Wachovia Stock Plan provided for awards of stock appreciation rights, or “SARs”, to participants. An SAR represents a right to receive a payment in cash, common stock, or a combination of both, equal to the excess of the fair market value of a specified number of shares of common stock on the date the SAR is exercised over an amount equal to the fair market value on the date the SAR was granted (or the option exercise price for SARs granted in tandem with an option). Each SAR grant is evidenced by an award agreement specifying the SAR exercise price, duration, the number of shares of common stock subject to the SAR, and whether the SAR is granted in tandem with an option or is freestanding. SARs granted in tandem with an option may be exercised for all or part of the shares subject to the related option but only to the extent that the related option is then exercisable. If the employment of a participant terminates by reason of displacement, death, disability or normal retirement, any then outstanding SARs granted to the participant will become immediately exercisable. Unless the compensation committee determines otherwise, any such outstanding SARs will be forfeited on the expiration date of the SARs or within a certain period after employment terminates, depending on the date of grant. Unless the compensation committee determines otherwise, if a participant’s employment terminates for any reason other than displacement, death, disability or normal retirement, (i) any then outstanding but unexercisable SARs granted to the participant will be forfeited, and (ii) any then outstanding and exercisable SARs granted to the participant will be forfeited on the expiration date of the SARs or three months after employment terminates, whichever period is shorter.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
In response to this Item, the information set forth in the Proxy Statement under the headings “Corporate Governance Policies and Practices – Director Independence” and “Other Matters Relating to Executive Officers and Directors and Related Party Transactions Policy” is incorporated herein by reference.
ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES.
In response to this Item, the information set forth in the Proxy Statement in the table and footnotes under the heading “Proposal to Ratify the Appointment of Auditors – Fees Paid to Independent Auditors” and under the heading “Proposal to Ratify the Appointment of Auditors – Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services” is incorporated herein by reference.
PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
(a) Our consolidated financial statements, including the notes thereto and independent auditors’ report thereon, are set forth on pages 62 through 129 of the Annual Report, and are incorporated herein by reference. All financial statement schedules are omitted since the required information is either not applicable, is immaterial or is included in our consolidated financial statements and notes thereto. A list of the exhibits to this Form 10-K is set forth on the Exhibit Index immediately preceding such exhibits and is incorporated herein by reference.
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. WACHOVIA CORPORATION Date: February 28, 2007 By: /s/ PETER M. CARLSON PETER M. CARLSON SENIOR VICE PRESIDENT Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated and on the date indicated. SIGNATURE G. KENNEDY THOMPSON* G. KENNEDY THOMPSON THOMAS J. WURTZ* THOMAS J. WURTZ PETER M. CARLSON* PETER M. CARLSON JOHN D. BAKER, II* JOHN D. BAKER, II ROBERT J. BROWN* ROBERT J. BROWN PETER C. BROWNING* PETER C. BROWNING JOHN T. CASTEEN, III* JOHN T. CASTEEN, III JEROME A. GITT* JEROME A. GITT WILLIAM H. GOODWIN, JR.* WILLIAM H. GOODWIN, JR. MARYELLEN C. HERRINGER* MARYELLEN C. HERRINGER ROBERT A. INGRAM* ROBERT A. INGRAM DONALD M. JAMES* DONALD M. JAMES MACKEY J. MCDONALD* MACKEY J. MCDONALD JOSEPH NEUBAUER* JOSEPH NEUBAUER CAPACITY Chairman, President, Chief Executive Officer and Director
Senior Executive Vice President and Chief Financial Officer
Senior Vice President and Corporate Controller (Principal Accounting Officer) Director
Director
Director
Director
Director
Director
Director
Director
Director
Director
Director
SIGNATURE
CAPACITY
TIMOTHY D. PROCTOR* TIMOTHY D. PROCTOR ERNEST S. RADY* ERNEST S. RADY VAN L. RICHEY* VAN L. RICHEY RUTH G. SHAW* RUTH G. SHAW LANTY L. SMITH* LANTY L. SMITH JOHN C. WHITAKER, JR.* JOHN C. WHITAKER, JR. DONA DAVIS YOUNG* DONA DAVIS YOUNG
Director
Director
Director
Director
Director
Director
Director
*By Mark C. Treanor, Attorney-in-Fact /s/ MARK C. TREANOR MARK C. TREANOR Date: February 28, 2007
EXHIBIT INDEX
EXHIBIT NO.
(3)(a)
DESCRIPTION
Restated Articles of Incorporation of Wachovia.
LOCATION
Incorporated by reference to Exhibit (3)(a) to Wachovia’s 2001 Third Quarter Report on Form 10-Q. Incorporated by reference to Exhibit (3)(b) to Wachovia’s. 2002 Annual Report on Form 10-K. Incorporated by reference to Exhibit (3)(c) to Wachovia’s 2002 Annual Report on Form 10-K. Incorporated by reference to Exhibit 4.1 to Wachovia’s Current Report on Form 8-K dated February 1, 2006. Incorporated by reference to Exhibit (3)(b) to Wachovia’s 2001 Third Quarter Report on Form 10-Q. *
(3)(b)
Articles of Amendment to Articles of Incorporation of Wachovia. Articles of Amendment to Articles of Incorporation of Wachovia. Articles of Amendment to Articles of Incorporation of Wachovia. Bylaws of Wachovia, as amended.
(3)(c)
(3)(d)
(3)(e)
(4)(a)
Instruments defining the rights of the holders of Wachovia’s long-term debt. Wachovia’s Shareholder Protection Rights Agreement.
(4)(b)
Incorporated by reference to Exhibit (4) to Legacy First Union’s Current Report on Form 8-K dated December 20, 2000. Incorporated by reference to Exhibit (10)(b) to Legacy First Union’s 1988 Annual Report on Form 10-K. Incorporated by reference to Exhibit (10)(c) to Legacy First Union’s 2000 Annual Report on Form 10-K. Incorporated by reference to Exhibit (10)(d) to Legacy First Union’s 1997 Annual Report on Form 10-K. Incorporated by reference to Exhibit (99) to Wachovia’s Current Report on Form 8-K dated January 5, 2005. Incorporated by reference to Exhibit (28) to Legacy First Union’s Registration Statement No. 33-47447. Incorporated by reference to Exhibit (4) to Legacy First Union’s Registration Statement No. 33-60913. Incorporated by reference to Exhibit (10)(e) to Wachovia’s Current Report on Form 8-K dated December 22, 2005. Incorporated by reference to Exhibit (10) to Legacy First Union’s 1996 First Quarter Report on Form 10-Q. Incorporated by reference to Exhibit (10)(j) to Wachovia’s 2001 Annual Report on Form 10-K. Incorporated by reference to Exhibit (10)(f) to Wachovia’s Current Report on Form 8-K dated December 22, 2005. Incorporated by reference to Exhibit (10) to Wachovia’s Current Report on Form 8-K dated December 1, 2006. Incorporated by reference to Exhibit (10) to Wachovia’s 2002 Second Quarter Report on Form 10-Q. Incorporated by reference to Exhibit (10)(n) to Wachovia’s 2002 Annual Report on Form 10-K. Incorporated by reference to Exhibit (10)(m) to Wachovia’s 2004 Annual Report on Form 10-K. Filed herewith.
(10)(a)
Wachovia’s Deferred Compensation Plan for Officers.
(10)(b)
Wachovia’s Deferred Compensation Plan for Non-Employee Directors, as amended. Wachovia’s Executive Deferred Compensation Plan.
(10)(c)
(10)(d)
Wachovia’s Supplemental Executive Long-Term Disability Plan, as amended and restated. Wachovia’s 1992 Master Stock Compensation Plan.
(10)(e)
(10)(f)
Wachovia’s Elective Deferral Plan.
(10)(g)
Amendment 2005-1 to Wachovia’s Elective Deferral Plan.
(10)(h)
Wachovia’s 1996 Master Stock Compensation Plan.
(10)(i)
Wachovia’s 1998 Stock Incentive Plan, as amended.
(10)(j)
Termination Agreement between Wachovia and G. Kennedy Thompson. Employment Agreement between Wachovia and Thomas J. Wurtz. Employment Agreements between Wachovia and Benjamin P. Jenkins, III and Stephen E. Cummings. Employment Agreement between Wachovia and Robert P. Kelly. Employment Agreement between Wachovia and David M. Carroll. Employment Agreement between Wachovia and Jean E. Davis. Amendment No. 1 to Employment Agreement between Wachovia and Jean E. Davis. Amendment No. 1 to Employment Agreements between Wachovia and Benjamin P. Jenkins, III, David M. Carroll, Stephen E. Cummings and Robert P. Kelly. Form of Employment Agreement between Wachovia and certain other Executive Officers of Wachovia.
(10)(k)
(10)(l)
(10)(m)
(10)(n)
(10)(o)
(10)(p)
Filed herewith.
(10)(q)
Incorporated by reference to Exhibit (10)(a) to Wachovia’s Current Report on Form 8-K dated December 22, 2005.
(10)(r)
Incorporated by reference to Exhibit (10)(m) to Wachovia’s 2001 Annual Report on Form 10-K.
EXHIBIT NO.
(10)(s)
DESCRIPTION
Amendment No. 2 to Employment Agreement between Wachovia and Jean E. Davis. Form of Amendment to Employment Agreement between Wachovia and certain other Executive Officers of Wachovia. Letter from Wachovia to Robert P. Kelly, dated January 31, 2006. Wachovia’s Senior Management Incentive Plan.
LOCATION
Filed herewith.
(10)(t)
Incorporated by reference to Exhibit (10)(c) to Wachovia’s Current Report on Form 8-K dated December 22, 2005. Incorporated by reference to Exhibit (10)(c) to Wachovia’s Current Report on Form 8-K dated January 31, 2006. Incorporated by reference to Exhibit (10)(t) to Legacy First Union’s 2000 Annual Report on Form 10-K. Incorporated by reference to Exhibit 10.14 to Legacy Wachovia’s 2000 Annual Report on Form 10-K. Filed herewith.
(10)(u)
(10)(v)
(10)(w)
Senior Executive Retirement Agreement between Legacy Wachovia and Jean E. Davis. Amendment No. 1 to Senior Executive Retirement Agreement Between Wachovia and Jean E. Davis. Form of Senior Executive Retirement Agreement between Wachovia and certain Executive Officers of Wachovia. Wachovia’s Amended and Restated Executive Deferred Compensation Plan. Wachovia’s 2001 Stock Incentive Plan.
(10)(x)
(10)(y)
Incorporated by reference to Exhibit 10.15 to Legacy Wachovia’s 1999 Annual Report on Form 10-K. Incorporated by reference to Exhibit 10.2 to Legacy Wachovia’s 2000 First Quarter Report on Form 10-Q. Incorporated by reference to Exhibit (10)(v) to Wachovia’s 2001 Annual Report on Form 10-K. Incorporated by reference to Exhibit 10.23 to Legacy Wachovia’s 2000 Third Quarter Report on Form 10-Q. Incorporated by reference to Exhibit 10.34 to Legacy Wachovia’s 1997 Annual Report on Form 10-K. Incorporated by reference to Exhibit 10.39 to Legacy Wachovia’s 2000 Third Quarter Report on Form 10-Q. Incorporated by reference to Exhibit 10.40 to Legacy Wachovia’s 2000 Third Quarter Report on Form 10-Q. Incorporated by reference to Exhibit (10)(ee) to Wachovia’s 2002 Annual Report on Form 10-K.
(10)(z)
(10)(aa)
(10)(bb)
Wachovia’s Stock Plan, as amended and restated.
(10)(cc)
Wachovia’s Executive Long-Term Disability Income Plan.
(10)(dd)
Form of Callable Split Dollar Insurance Agreement between Wachovia and certain Executive Officers of Wachovia. Form of Non-Callable Split Dollar Insurance Agreement between Wachovia and certain Executive Officers of Wachovia. Form of Split Dollar Life Insurance Agreement between Wachovia and G. Kennedy Thompson, Benjamin P. Jenkins, III, and certain Executive Officers of Wachovia. Wachovia’s Employee Retention Stock Plan.
(10)(ee)
(10)(ff)
(10)(gg)
Incorporated by reference to Exhibit (10)(ff) to Wachovia’s 2002 Annual Report on Form 10-K. Incorporated by reference to Exhibit (10)(gg) to Wachovia’s 2002 Annual Report on Form 10-K. Incorporated by reference to Exhibit (10) to Wachovia’s 2003 First Quarter Report on Form 10-Q. Incorporated by reference to Appendix E to Wachovia’s Registration Statement on Form S-4 (Reg. No. 333-134656). Filed with the Commission on July 24, 2006. Incorporated by reference to Exhibit (10)(ff) to Wachovia’s 2003 Annual Report on Form 10-K. Incorporated by reference to Exhibit (10)(gg) to Wachovia’s 2003 Annual Report on Form 10-K. Incorporated by reference to Exhibit (10)(hh) to Wachovia’s 2003 Annual Report on Form 10-K.
(10)(hh)
Wachovia’s Savings Restoration Plan.
(10)(ii)
Wachovia’s 2003 Stock Incentive Plan.
(10)(jj)
Amended and Restated Wachovia’s 2003 Stock Incentive Plan.
(10)(kk)
Split-Dollar Life Insurance Termination Agreement between Wachovia and G. Kennedy Thompson. Insurance Bonus Agreement between Wachovia and G. Kennedy Thompson. Form of Split-Dollar Life Insurance Termination Agreement between Wachovia and certain Executive Officers of Wachovia, including David M. Carroll. Form of Insurance Bonus Agreement between Wachovia and certain Executive Officers of Wachovia, including Robert P. Kelly and Stephen E. Cummings. Split-Dollar Insurance Special Election Form between Wachovia and Benjamin P. Jenkins, III. Split Dollar Life Insurance Termination Agreement between Wachovia and Jean E. Davis.
(10)(ll)
(10)(mm)
(10)(nn)
Incorporated by reference to Exhibit (10)(ii) to Wachovia’s 2003 Annual Report on Form 10-K.
(10)(oo)
Incorporated by reference to Exhibit (10)(jj) to Wachovia’s 2003 Annual Report on Form 10-K. Filed herewith.
(10)(pp)
EXHIBIT NO.
(10)(qq)
DESCRIPTION
Insurance Bonus Agreement between Wachovia and
LOCATION
Filed herewith.
Jean E. Davis. (10)(rr) SouthTrust Corporation Long-Term Incentive Plan. Incorporated by reference to Exhibit 2 to SouthTrust’s 2000 Proxy Statement on Schedule 14A, filed March 6, 2000. Incorporated by reference to Appendix B to SouthTrust’s 2004 Proxy Statement on Schedule 14A, filed March 8, 2004. Incorporated by reference to Exhibit (10)(d) to SouthTrust’s 2001 Annual Report on Form 10-K. Incorporated by reference to Exhibit (99)(c) to Wachovia’s Current Report on Form 8-K dated May 2, 2005. Incorporated by reference to Exhibit (10)(f) to Wachovia’s Current Report on Form 8-K dated May 2, 2005. Incorporated by reference to Exhibit (10)(g) to SouthTrust’s 2001 Annual Report on Form 10-K. Incorporated by reference to Exhibit (10)(d) to Wachovia’s Current Report on Form 8-K dated December 22, 2005. Incorporated by reference to Exhibit (10)(h) to SouthTrust’s 2001 Annual Report on Form 10-K. Incorporated by reference to Exhibit (10)(i) to SouthTrust’s 2001 Annual Report on Form 10-K. Incorporated by reference to Exhibit (10)(n) to SouthTrust’s 2001 Annual Report on Form 10-K. Incorporated by reference to Exhibit (10)(b) to Wachovia’s Current Report on Form 8-K dated December 22, 2005. Incorporated by reference to Exhibit (10)(a) to Wachovia’s Current Report on Form 8-K dated January 3, 2006. Incorporated by reference to Exhibit (10)(a) to SouthTrust’s 2002 First Quarter Report on Form 10-Q. Incorporated by reference to Appendix C to SouthTrust’s 2004 Proxy Statement on Schedule 14A, filed March 8, 2004. Incorporated by reference to Exhibit (10)(ss) to Wachovia’s 2004 Annual Report on Form 10-K. Incorporated by reference to Exhibit (99)(a) to Wachovia’s Current Report on Form 8-K dated May 2, 2005. Incorporated by reference to Wachovia’s Current Report on Form 8-K dated June 22, 2005. Incorporated by reference to Exhibit (10)(b) to Wachovia’s 2006 Third Quarter Report on Form 10-Q. Filed herewith. Filed herewith.
(10)(ss)
SouthTrust Corporation Amended and Restated Senior Officer Performance Incentive Plan. SouthTrust Corporation Performance Incentive Retirement Benefit Plan. Amended and Restated SouthTrust Corporation Deferred Compensation Plan, as amended and restated. SouthTrust Corporation Enhanced Retirement Benefit Plan, as amended and restated SouthTrust Corporation Wallace D. Malone, Jr., Nonqualified Deferred Compensation Plan. Amendment 2005-1 to SouthTrust Corporation Wallace D. Malone, Jr. Nonqualified Deferred Compensation Plan. Amended and Restated SouthTrust Corporation Executive Deferred Compensation Plan. SouthTrust Corporation Wallace D. Malone, Jr., Second Nonqualified Deferred Compensation Plan. Amended and Restated Employment Agreement for Wallace D. Malone, Jr. Amendment No. 1 to Amended and Restated Employment Agreement for Wallace D. Malone, Jr. Amendment No. 2 to Amended and Restated Employment Agreement for Wallace D. Malone, Jr. SouthTrust Corporation Executive Management Retirement Plan.
(10)(tt)
(10)(uu)
(10)(vv)
(10)(ww)
(10)(xx)
(10)(yy)
(10)(zz)
(10)(aaa)
(10)(bbb)
(10)(ccc)
(10)(ddd)
(10)(eee)
SouthTrust Corporation 2004 Long-Term Incentive Plan.
(10)(fff)
Form of stock award agreements for Executive Officers of Wachovia. Wachovia Corporation Executive Severance Pay Plan.
(10)(ggg)
(10)(hhh)
Compensation for Non-Employee Directors of Wachovia.
(10)(iii)
Ernest S. Rady compensation arrangement.
(10)(jjj) (12)(a)
Legacy First Union Benefit Restoration Plan. Computations of Consolidated Ratios of Earnings to Fixed Charges. Computations of Consolidated Ratios of Earnings to Fixed Charges and Preferred Stock Dividends Wachovia’s 2006 Annual Report to Stockholders.** List of Wachovia’s subsidiaries. Consent of KPMG LLP. Power of Attorney. Certification of principal executive officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Certification of principal financial officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
(12)(b)
Filed herewith.
(13) (21) (23) (24) (31)(a)
Filed herewith. Filed herewith. Filed herewith. Filed herewith. Filed herewith.
(31)(b)
Filed herewith.
EXHIBIT NO.
(32)(a)
DESCRIPTION
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
LOCATION
Filed herewith.
(32)(b)
Certification pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Declaration of Covenant of Wachovia, dated February 1, 2006. Replacement Capital Covenant of Wachovia, dated February 15, 2007.
Filed herewith.
(99)(a)
Incorporated by reference to Exhibit 99.1 to Wachovia’s Current Report on Form 8-K dated February 1, 2006. Incorporated by reference to Exhibit 99.1 to Wachovia’s Current Report on Form 8-K dated February 15, 2007.
(99)(b)
*
We agree to furnish to the SEC upon request, copies of the instruments, including indentures, defining the rights of the holders of our long-term debt and of our subsidiaries’ long-term debt.
** Except for those portions of the Annual Report that are expressly incorporated by reference in this Form 10-K, the Annual Report is furnished for the information of the SEC only and is not to be deemed “filed” as part of this Form 10-K.
EMPLOYMENT AGREEMENT
Exhibit (10)(o)
This EMPLOYMENT AGREEMENT, made and entered into as of the 1st day of November, 2001, by and between Wachovia Corporation (the “Company”), a North Carolina corporation, and JEAN E. DAVIS (the “Executive”); WHEREAS, the Management Resources & Compensation Committee (the “Committee”) of the Board of Directors of the Company (the “Board”) has determined that it is in the best interests of the Company and its stockholders to assure that the Company will have the continued service of the Executive. The Committee believes it is imperative to encourage the Executive’s full attention and dedication to the Company, and to provide the Executive with compensation and benefits arrangements upon a termination of employment with the Company which ensure that the compensation and benefits expectations of the Executive will be satisfied and which are competitive with those of other corporations. NOW, THEREFORE, in order to accomplish the objectives set forth above and in consideration of the mutual covenants herein contained, the parties hereby agree as follows: 1. Employment Period. (a) The “Effective Date” shall mean the date hereof.
(b) The Company hereby agrees to continue the Executive in its employ, and the Executive hereby agrees to remain in the employ of the Company upon the terms and conditions set forth in this Agreement, for the period commencing on the Effective Date and ending on the third anniversary thereof (the “Employment Period”); provided, however, that commencing on the date one year after the date hereof, and on each annual anniversary of such date (such date and each annual anniversary thereof shall be hereinafter referred to as the “Renewal Date”), unless previously terminated, the Employment Period shall be automatically extended so as to terminate three years from such Renewal Date, unless at least 90 days prior to the Renewal Date the Company or the Executive, respectively, shall give notice to the Executive or the Company, respectively, that the Employment Period shall not be so extended. Notwithstanding the foregoing, in the event a “Change in Control” (as defined herein) occurs, the Employment Period, unless previously terminated, shall be extended immediately prior to the Change in Control so that the Employment Period shall terminate no earlier than three years from such Change in Control. 2. Terms of Employment. (a) Positions and Duties. (i) During the Employment Period, the Company agrees to employ the Executive, and the Executive agrees to serve as an employee of the Company and as an employee of one or more of its subsidiaries. The Executive shall perform such duties and responsibilities, in such capacity and with such authority, for the Company (or one or more of its subsidiaries) as the Company may designate from time to time. Such duties shall be of a type for which the Executive is suited by background, experience and training, in the Company’s reasonable discretion.
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(ii) During the Employment Period, and excluding any periods of vacation and sick leave to which the Executive is entitled, the Executive agrees to devote his full professional attention and time during normal business hours to the business and affairs of the Company and to perform the responsibilities assigned to the Executive hereunder. During the Employment Period it shall not be a violation of this Agreement for the Executive to (A) serve on corporate, civic or charitable boards or committees, (B) deliver lectures, fulfill speaking engagements or teach at educational institutions, and (C) manage personal investments, so long as such activities do not interfere with the performance of the Executive’s responsibilities as an employee of the Company in accordance with this Agreement and are consistent with the Company’s policies. It is expressly understood and agreed that to the extent that any such activities have been conducted by the Executive prior to the Effective Date, the continued conduct of such activities (or the conduct of activities similar in nature and scope thereto) subsequent to the Effective Date shall not thereafter be deemed to interfere with the performance of the Executive’s responsibilities to the Company. (b) Compensation. (i) Salary and Bonus. For all services rendered by the Executive in any capacity under this Agreement, the Company shall pay the Executive during the Employment Period as compensation (i) an annual salary in an amount not less than the amount of the Executive’s annual salary as of the Effective Date (the “Annual Base Salary”) and (ii) such annual cash incentive bonus, if any, as may be awarded to him by the Board or by a Committee designated by the Board (the “Annual Bonus”). Such salary shall be payable in accordance with the Company’s customary payroll practices, and any such bonus shall be payable in cash in accordance with the Company’s incentive bonus plans from which the Annual Bonus is awarded. During the Employment Period prior to the Date of Termination, the Annual Base Salary shall be reviewed in accordance with the Company’s policies and procedures applicable to the Executive and may be increased from time to time consistent with such procedures. Any increase in Annual Base Salary shall not serve to limit or reduce any other obligation to the Executive under this Agreement. In the event the Executive’s actual Annual Base Salary is increased above the then current Annual Base Salary during the Employment Period, such increased Annual Base Salary shall constitute “Annual Base Salary” for purposes of this Agreement, and may not thereafter be reduced except with the written consent of the Executive. (ii) Employee Benefits. During the Employment Period prior to the Date of Termination, the Executive and/or the Executive’s family, as the case may be, shall be eligible to participate in employee benefit plans generally available to other peer executives of the Company or its subsidiaries, including without limitation, employee stock purchase plans, savings plans, retirement plans, welfare benefit plans (including, without limitation, medical, prescription, dental, disability, life, accidental death, and travel accident insurance, but excluding severance plans) and similar plans, practices, policies and programs. In addition, during the Employment Period, the Executive shall be eligible to participate in the Company’s stock-based incentive compensation plans then available to other peer executives of the Company with awards thereunder determined by the Board or by a Committee designated by the
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Board, in its sole discretion, except as provided in this Agreement. (iii) Expenses. During the Employment Period prior to the Date of Termination, the Executive shall be entitled to receive prompt reimbursement for all reasonable expenses incurred by the Executive in accordance with the policies, practices and procedures of the Company and its affiliated companies in effect for the Executive at the time the expense is incurred. (iv) Fringe Benefits. During the Employment Period prior to the Date of Termination, the Executive shall be entitled to fringe benefits and perquisite plans or programs of the Company and its affiliated companies generally available to executives who are peers of the Executive; provided that the Company reserves the right to modify, change or terminate such fringe benefits and perquisite plans or programs from time to time, in its sole discretion. (v) Indemnification/D&O Insurance. During the Employment Period for acts prior to the Date of Termination, the Executive shall be entitled to indemnification with respect to the performance of his duties hereunder, and directors’ and officers’ liability insurance, on the same terms and conditions as generally available to other peer executives of the Company and its affiliated companies. (vi) SERP Benefits. During the Employment Period, the Executive shall continue to accrue the benefits under the Senior Executive Retirement Agreement, dated October 22, 1999, between the Company (as successor to the former Wachovia Corporation) and the Executive (the “SERP Agreement”). Pursuant to Section 2(b) of the SERP Agreement, the provisions of this Agreement, including Section 1(b) above, constitute an agreement between the Company and the Executive to extend the Executive’s employment past the “Normal Retirement Date” (as defined in the SERP Agreement) if the Executive’s employment extends beyond such date. In addition, the Company hereby agrees that the “Committee” (as defined in the SERP Agreement) has approved and the Executive may elect a lump sum payment option under Section 5 of the SERP Agreement. (a) Retirement, Death or Disability. 3. Termination of Employment. The Executive’s employment shall terminate automatically upon the Executive’s death or Retirement (as defined herein) during the Employment Period. For purposes of this Agreement, “Retirement” shall mean either (i) voluntary termination by the Executive of the Executive’s employment upon satisfaction of the requirements for early retirement under the Company’s tax-qualified defined benefit pension plan or (ii) voluntary termination by the Executive of the Executive’s employment upon satisfaction of the requirements for normal retirement under the terms of the Company’s tax-qualified pension plan. If the Company determines in good faith that Disability of the Executive has occurred during the Employment Period (pursuant to the definition of Disability set forth below), it may give to the Executive written notice in accordance with this Agreement of its intention to terminate the Executive’s employment. In such event, the Executive’s employment with the Company shall terminate effective on the 30th day after receipt of such notice by the Executive (the
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“Disability Effective Date”), provided that, within the 30 days after such receipt, the Executive shall not have returned to full-time performance of the Executive’s duties. For purposes of this Agreement, “Disability” shall mean termination of the Executive’s employment upon satisfaction of the requirements to receive benefits under the Company’s long-term disability plan. (b) Cause. The Company may terminate the Executive’s employment during the Employment Period for Cause. For purposes of this Agreement, “Cause” shall mean: (i) the continued and willful failure of the Executive to perform substantially the Executive’s duties with the Company or one of its affiliates (other than any such failure resulting from incapacity due to physical or mental illness), after a written demand for substantial performance is delivered to the Executive by the Company which specifically identifies the manner in which the Company believes that the Executive has not substantially performed the Executive’s duties and a reasonable time for such substantial performance has elapsed since delivery of such demand, or (ii) the willful engaging by the Executive in illegal conduct or gross misconduct which is materially injurious to the Company. For purposes of this provision, no act or failure to act, on the part of the Executive, shall be considered “willful” unless it is done, or omitted to be done, by the Executive in bad faith or without reasonable belief that the Executive's action or omission was in the best interests of the Company. Any act, or failure to act, based upon authority given pursuant to a resolution duly adopted by the Board or upon the instructions of the Chairman of the Board or a senior executive officer of the Company or based upon the advice of counsel for the Company shall be conclusively presumed to be done, or omitted to be done, by the Executive in good faith and in the best interests of the Company. Following a Change in Control (as defined herein), the Company’s termination of the Executive’s employment shall not be deemed to be for Cause unless and until there shall have been delivered to the Executive a copy of a resolution duly adopted by the affirmative vote of not less than three-fourths of the entire membership of the Board at a meeting of the Board called and held for such purpose (after reasonable notice is provided to the Executive and the Executive is given an opportunity, together with counsel, to be heard before such Board), finding that, in the good faith opinion of such Board, the Executive is guilty of the conduct described in subparagraph (i) or (ii) above, and specifying the particulars thereof in detail. (c) Good Reason. The Executive’s employment may be terminated by the Executive for Good Reason. For purposes of this Agreement, “Good Reason” shall mean, in the absence of a written consent of the Executive which expressly refers to a provision of this Section 3(c): (i) prior to a Change in Control, the substantial diminution in the overall importance of the Executive’s role, as determined by balancing (A) any increase or decrease in the scope of the Executive’s management responsibilities against (B)
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any increase or decrease in the relative sizes of the businesses, activities or functions (or portions thereof) for which the Executive has responsibility; provided, however, that none of (I) a change in the Executive’s title, (II) a change in the hierarchy, (III) a change in the Executive’s responsibilities from line to staff or vice versa, and (IV) placing the Executive on temporary leave pending an inquiry into whether the Executive has engaged in conduct that could constitute “Cause” under this Agreement, either individually or in the aggregate shall be considered Good Reason; (ii) any failure by the Company to comply with any material provision of this Agreement (including, without limitation, any provision of Section 2 of this Agreement), other than an isolated, insubstantial and inadvertent failure not occurring in bad faith and which is remedied by the Company promptly after receipt of notice thereof given by the Executive; (iii) any purported termination by the Company of the Executive’s employment otherwise than as expressly permitted by this Agreement; (iv) at any time prior to the Executive reaching age 63, the Company giving notice to the Executive of its intention not to extend the term of this Agreement as provided in Section 1(b); (v) following a Change in Control, the relocation of the principal place of the Executive’s employment to a location that is more than 35 miles from such principal place of employment immediately prior to the date the proposed Change in Control is publicly announced, or the Company’s requiring the Executive to travel on Company business to a substantially greater extent than required immediately prior to the Change in Control; (vi) following a Change in Control, the Company’s requiring the Executive or all or substantially all of the employees of the Company who report directly to the Executive immediately prior to the date the proposed Change in Control is publicly announced to be based at any office or location other than such person’s office or location on such date; (vii) any failure by the Company to comply with and satisfy Section 9(c) of this Agreement; (viii) following a Change in Control, assignment to the Executive of any duties inconsistent in any respect with the Executive’s position as in effect immediately prior to the public announcement of the proposed Change in Control (including status, offices, titles and reporting requirements), authority, duties or responsibilities, or any other action by the Company which results in any diminution in such position, authority, duties or responsibilities; or (ix) the Executive terminating employment for any reason during the period from January 1, 2003 to June 30, 2003.
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For purposes of this Section 3(c), any good faith determination of “Good Reason” made by the Executive after a Change in Control shall be conclusive (including any such determination when the Executive is then eligible for Retirement). In the event the Company challenges the Executive’s determination of Good Reason, the Company shall continue to make the payments and provide the benefits to the Executive as set forth in Section 4(a). If it is finally determined pursuant to the procedures set forth in this Agreement that the Executive’s termination was not for Good Reason, the Executive shall reimburse the Company the amounts to which it is finally determined to be entitled. (d) Notice of Termination. Any termination by the Company for Cause, or by the Executive for Good Reason, shall be communicated by Notice of Termination to the other party hereto given in accordance with this Agreement. For purposes of this Agreement, a “Notice of Termination” means a written notice which (i) indicates the specific termination provision in this Agreement relied upon, (ii) to the extent applicable, sets forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive’s employment under the provision so indicated and (iii) if the Date of Termination (as defined below) is other than the date of receipt of such notice, specifies the termination date (which date shall be not more than 30 days after the giving of such notice). The failure by the Executive or the Company to set forth in the Notice of Termination any fact or circumstance which contributes to a showing of Good Reason or Cause shall not waive any right of the Executive or the Company, respectively, hereunder or preclude the Executive or the Company, respectively, from asserting such fact or circumstance in enforcing the Executive’s or the Company’s rights hereunder. To be effective, a Notice of Termination given by the Executive terminating employment with the Company for Good Reason must be received by the Company no later than 60 days from the event(s) giving rise to the Good Reason termination. (e) Date of Termination. “Date of Termination” means (i) if the Executive’s employment is terminated by the Company for Cause, the date of receipt of the Notice of Termination, unless the Company agrees to a later date no more than 30 days after such notice, as the case may be, (ii) if the Executive’s employment is terminated by the Executive for Good Reason or Retirement, the date of receipt of the Notice of Termination or any later date specified therein within 30 days of such notice, as the case may be, (iii) if the Executive’s employment is terminated by the Company other than for Cause or Disability, the date on which the Company notifies the Executive of such termination or any later date specified therein within 30 days of such notice, as the case may be, (iv) if the Executive’s employment is terminated by reason of death or Disability, the date of death of the Executive or the Disability Effective Date, as the case may be, and (v) if the Executive’s employment is terminated by the Executive for other than Good Reason, death, Disability or Retirement, the date that is 60 days after the date of receipt of the Notice of Termination by the Company, provided, however, the Company may elect to waive such notice or place the Executive on paid leave for all or any part of such 60-day period during which the Executive will be entitled to continue to receive the Annual Base Salary but shall not receive any Annual Bonus or any other payment from the Company other than reimbursement for
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expenses as contemplated in Section 2(b)(iii) and continued participation in the employee benefit plans as contemplated in Section 2(b)(ii). (f) Change in Control. For purpose of this Agreement, a “Change in Control” shall mean: (i) The acquisition by any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) (a “Person”) of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of either (A) the then outstanding shares of common stock of the Company (the “Outstanding Company Common Stock”) or (B) the combined voting power of the then outstanding voting securities of the Company entitled to vote generally in the election of directors (the “Outstanding Company Voting Securities”; provided, however, that for purposes of this subsection (i), the following acquisitions shall not constitute a Change in Control: (1) any acquisition directly from the Company, (2) any acquisition by the Company, (3) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or any corporation controlled by the Company or (4) any acquisition by any corporation pursuant to a transaction which complies with clauses (A), (B) and (C) of subsection (iii) of this Section 3(f); or (ii) Individuals who, as of the date hereof, constitute the Board (the “Incumbent Board”) cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director subsequent to the date hereof whose election, or nomination for election by the Company’s shareholders, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board (either by a specific vote or by approval of the proxy statement of the Company in which such person is named as a nominee for director, without written objection to such nomination) shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or contests by or on behalf of a Person other than the Board; or (iii) Consummation of a reorganization, merger, share exchange or consolidation or sale or other disposition of all or substantially all of the assets of the Company (a “Business Combination”), in each case, unless, following such Business Combination, (A) all or substantially all of the individuals and entities who were the beneficial owners, respectively, of the Outstanding Company Common Stock and Outstanding Company Voting Securities immediately prior to such Business Combination beneficially own, directly or indirectly, more than 60% of, respectively, the then outstanding shares of common stock and the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the corporation resulting from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns the Company or all or substantially all of the Company’s assets either directly or
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through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Business Combination of the Outstanding Company Common Stock and Outstanding Company Voting Securities, as the case may be, (B) no Person (excluding any corporation resulting from such Business Combination or any employee benefit plan (or related trust) of the Company or such corporation resulting from the Business Combination) beneficially owns, directly or indirectly, 20% or more of, respectively, the then outstanding shares of common stock of the corporation resulting from such Business Combination or the combined voting power of the then outstanding voting securities of such corporation except to the extent that such ownership existed prior to the Business Combination and (C) at least a majority of the members of the board of directors of the corporation resulting from such Business Combination were members of the Incumbent Board immediately prior to the time of the execution of the initial agreement, or of the action of the Board, providing for such Business Combination; or (iv) Approval by the stockholders of the Company of a complete liquidation or dissolution of the Company. 4. Obligations of the Company upon Termination. (a) Good Reason; Company Termination other than for Cause, Death, Disability or Retirement. If, during the Employment Period, the Company shall terminate the Executive’s employment other than for Cause, Death, Disability or Retirement or the Executive shall terminate employment for Good Reason: (i) the Company shall pay to the Executive in a lump sum in cash within 30 days after the Date of Termination the aggregate of (A) the Executive’s Annual Base Salary through the Date of Termination to the extent not theretofore paid, and (B) the product of (1) an Annual Bonus of an amount equal to the greater of (x) the highest annual cash incentive bonus paid by the Company to the Executive for the three calendar years prior to the Date of Termination or (y) the Executive’s then applicable “target” incentive bonus under the then applicable cash incentive compensation plan prior to the Date of Termination (the greater of clauses (x) or (y) is defined as the “Base Bonus”), and (2) a fraction, the numerator of which is the number of days in the fiscal year in which the Date of Termination occurs through the Date of Termination, and the denominator of which is 365, to the extent not theretofore paid (the “Pro Rata Bonus”), (C) any unpaid Annual Bonus for the prior year, (D) any compensation previously deferred by the Executive (together with any accrued interest or earnings thereon) and (E) any accrued paid time off, in each case to the extent not theretofore paid (the sum of the amounts described in clauses (A), (B), (C), (D) and (E) shall be hereinafter referred to as the “Accrued Obligations”). For purposes of determining the Base Bonus hereunder, the Company shall exclude any special or one-time bonuses and any premium enhancements to bonuses but shall include any portions of bonuses (other than the excluded bonuses) which have been deferred by the Executive; (ii)
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Termination (the “Compensation Continuance Period”), the Company shall pay to the Executive a cash benefit equal to the sum of (A) the Executive’s highest Annual Base Salary during the twelve months immediately prior to the Date of Termination, (B), the Base Bonus, and (C) the amount equal to the highest matching contribution by the Company to the Executive’s account in the Company’s 401(k) plan for the five years immediately prior to the Date of Termination (the payments described in clauses (A), (B) and (C) shall be hereinafter referred to as the “Compensation Continuance Payments” and, together with the benefits referred to in Sections 4(a)(iii), (iv), (v), (vi), (vii) and (viii), shall be hereinafter referred to as the “Compensation Continuance Benefits”). The Company shall make the Compensation Continuance Payments no more frequently than semi-monthly (and may make the Compensation Continuance Payments in accordance with the Company’s normal payroll policies and practices), and shall withhold from the Compensation Continuance Payments all applicable federal, state and local taxes. Notwithstanding anything contained in this Agreement to the contrary, in the event a Change of Control has occurred on or prior to the Date of Termination, the Company shall pay the Compensation Continuance Payments to the Executive in a lump sum in cash within 30 days after the Date of Termination. (iii) during the Compensation Continuance Period (or for the remainder of the Executive’s life if such Date of Termination is after a Change in Control), or such longer period as may be provided by the terms of the appropriate plan, program, practice or policy, the Company shall continue medical, dental and life insurance benefits to the Executive and/or the Executive’s family on a substantially equivalent basis to those which would have been provided to them in accordance with the medical, dental and life insurance plans, programs, practices and policies described in Section 2(b)(iv) of this Agreement if the Executive’s employment had not been terminated. Notwithstanding the foregoing, in the event the Executive becomes reemployed with another employer and becomes eligible to receive medical, dental and/or life insurance benefits from such employer, the medical, dental and/or life insurance benefits described herein shall be secondary to such benefits during the period of the Executive’s eligibility, but only to the extent that the Company reimburses the Executive for any increased cost and provides any additional benefits necessary to give the Executive the benefits provided hereunder. For purposes of determining eligibility (but not the time of commencement of benefits) of the Executive for retiree benefits pursuant to such plans, practices, programs and policies, the Executive shall be considered to have terminated employment with the Company on the Date of Termination. Notwithstanding the foregoing, if the Company reasonably determines that providing continued coverage under one or more of its welfare benefit plans contemplated herein could adversely affect the tax treatment of other participants covered under such plans, or would otherwise have adverse legal ramifications, the Company may, in its discretion, either (A) provide other coverage at least as valuable as the continued coverage through insurance or otherwise, or (B) pay the Executive a lump sum cash amount that reasonably approximates the after-tax value to the Executive of the premiums for continued coverage, in lieu of providing such continued coverage; (iv) during the Compensation Continuance Period, to the extent
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not otherwise vested in accordance with the Company’s stock compensation plans, all unvested options to purchase shares of Company common stock and restricted stock awards will continue to vest in accordance with the applicable terms of such stock option or restricted stock grants as if the Executive’s employment with the Company had not been terminated. At the end of the Compensation Continuance Period, to the extent not otherwise vested in accordance with the preceding sentence, all unvested stock options and restricted stock awards will vest. Notwithstanding the termination of the Executive’s employment with the Company, all stock options granted to the Executive as of the date of this Agreement and during the Employment Period will be exercisable until the scheduled expiration date of such stock options; provided, however, in the event any such stock options are designated as “incentive stock options” pursuant to section 422 of the Code (as defined herein), such stock options shall be treated as non-qualified stock options for purposes of this sentence to the extent that they are exercised after the period specified in section 422(a)(2) of the Code (to the extent such provision applies); (v) during the Compensation Continuance Period, the Executive shall be entitled to continue to participate in the Company’s fringe benefit and perquisite plans or programs in which the Executive participated immediately prior to the Date of Termination, in each case in accordance with the Company’s plans, programs, practices and policies; (vi) to the extent not theretofore paid or provided, the Company shall timely pay or provide to the Executive any other amounts or benefits required to be paid or provided or which the Executive is eligible to receive under any plan, program, policy or practice or contract or agreement of the Company and its affiliated companies (excluding any severance plan, program, policy or practice) through the Date of Termination (such other amounts and benefits shall be hereinafter referred to as the “Other Benefits”); (vii) the Company will provide outplacement services to the Executive in accordance with the Company’s policies generally applicable to involuntarily terminated employees; and (viii) for the purpose of computing the benefits payable to the Executive under the SERP Agreement (A) the Executive shall be credited with service as if the Executive continued to be employed by the Company during the Compensation Continuance Period, and (B) one-third of the aggregate Compensation Continuance Payments (whether or not such payments are paid in a lump sum) shall be considered as the annual compensation paid to the Executive during each year of the Compensation Continuance Period. (b) Death. If the Executive’s employment is terminated by reason of the Executive’s death during the Employment Period, this Agreement shall terminate without further obligations to the Executive’s legal representatives under this Agreement, other than for payment of Accrued Obligations, Other Benefits, and the payment of an amount equal to the Executive’s Annual Base Salary. Accrued
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Obligations and cash payments pursuant to the preceding sentence shall be paid to the Executive’s estate or beneficiary, as applicable, in a lump sum in cash within 30 days of the Date of Termination. With respect to the provision of Other Benefits, the term Other Benefits as utilized in this Section 4(b) shall include, without limitation, and the Executive’s estate and/or beneficiaries shall be entitled to receive, death benefits then applicable to the Executive. (c) Retirement. If the Executive’s employment is terminated by reason of the Executive’s Retirement during the Employment Period, this Agreement shall terminate without further obligations to the Executive under this Agreement, other than for payment of Accrued Obligations and Other Benefits. Accrued Obligations shall be paid to the Executive in a lump sum in cash within 30 days of the Date of Termination. With respect to the provision of Other Benefits, the term Other Benefits as utilized in this Section 4(c) shall include, without limitation, and the Executive shall be entitled to receive, all retirement benefits then applicable to the Executive, including but not limited to any SERP benefits then applicable to the Executive under the SERP Agreement. (d) Disability. If the Executive’s employment is terminated by reason of the Executive’s Disability during the Employment Period, this Agreement shall terminate without further obligations to the Executive, other than for payment of Accrued Obligations, Other Benefits, and the payment of an amount equal to the Executive’s Annual Base Salary. Accrued Obligations and the cash payments pursuant to the preceding sentence shall be paid to the Executive in a lump sum in cash within 30 days of the Date of Termination. With respect to the provision of Other Benefits, the term Other Benefits as utilized in this Section 4(d) shall include, and the Executive shall be entitled after the Disability Effective Date to receive, disability and other benefits then applicable to the Executive. (e) Cause; Other than for Good Reason. If the Executive’s employment shall be terminated by the Company for Cause or by the Executive without Good Reason (other than for Retirement) during the Employment Period, this Agreement shall terminate without further obligations of the Company to the Executive other than the obligation to pay to the Executive (x) his Annual Base Salary through the Date of Termination, (y) the amount of any compensation previously deferred by the Executive, and (z) Other Benefits, in each case only to the extent owing and theretofore unpaid. 5. Non-exclusivity of Rights. Nothing in this Agreement shall prevent or limit the Executive’s continuing or future participation in any plan, program, policy or practice provided by the Company or any of its affiliated companies and for which the Executive may qualify (excluding any severance plan or program of the Company), nor subject to Section 11(f), shall anything herein limit or otherwise affect such rights as the Executive may have under any contract or agreement with the Company or any of its affiliated companies. Amounts which are vested benefits or which the Executive is otherwise entitled to receive under any plan, policy, practice or program of or any contract or agreement with the Company or any of its affiliated companies at or
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subsequent to the Date of Termination shall be payable in accordance with such plan, policy, practice or program or contract or agreement except as explicitly modified by this Agreement. 6. Full Settlement. Except as specifically provided in this Agreement, the Company’s obligation to make the payments provided for in this Agreement and otherwise to perform its obligations hereunder shall not be affected by any set-off, counterclaim, recoupment, defense or other claim, right or action which the Company may have against the Executive or others. In no event shall the Executive be obligated to seek other employment or take any other action by way of mitigation of the amounts payable to the Executive under any of the provisions of this Agreement and, such amounts shall not be reduced whether or not the Executive obtains other employment. The Executive acknowledges and agrees that subject to the payment by the Company of the benefits provided in this Agreement to the Executive, in no event will the Company or its subsidiaries or affiliates be liable to the Executive for damages under any claim of breach of contract as a result of the termination of the Executive’s employment. In the event of such termination, the Company shall be liable only to provide the benefits specified in this Agreement. The Company agrees to pay as incurred, to the full extent permitted by law, all legal fees and expenses which the Executive may reasonably incur as a result of any contest by the Company, the Executive or others of the validity or enforceability of, or liability under, any provision of this Agreement or any guarantee of performance thereof (including as a result of any contest by the Executive about the amount of any payment pursuant to this Agreement), plus in each case interest on any delayed payment at the applicable Federal rate provided for in Section 7872(f)(2)(A) of the Internal Revenue Code of 1986, as amended (the “Code”). Notwithstanding the foregoing, if it is finally judicially determined that the Executive brought any claims contemplated in the previous sentence in bad faith, the Executive shall reimburse the Company for such fees and expenses which are reasonably related to such bad faith claim. 7. Covenants. (a) The Executive shall hold in a fiduciary capacity for the benefit of the Company all secret, non-public or confidential information, knowledge or data relating to the Company or any of its affiliated companies, and their related businesses, which shall have been obtained by the Executive during the Executive’s employment by the Company or any of its affiliated companies (or predecessors thereto). After termination of the Executive’s employment with the Company, the Executive shall not, without the prior written consent of the Company or as may otherwise be required by law or legal process, communicate or divulge any such information, knowledge or data to anyone other than the Company and those designated by it. In addition to the foregoing, the Executive will refrain from taking any action or making any statements, written or oral, which are intended to or which disparage the business, goodwill or reputation of the Company or any of its affiliated companies, or their respective directors, officers, executives or other employees, or which could adversely affect the morale of employees of the Company or any of its affiliated companies. (b)
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(i) While employed by the Company and for three years after the
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Date of Termination (which may include the Compensation Continuance Period), the Executive shall not, directly or indirectly, on behalf of the Executive or any other person, (A) solicit for employment by other than the Company, (B) encourage to leave the employ of the Company, or (C) interfere with the Company’s or its affiliated companies’ relationship with, any person employed by the Company or its affiliated companies. (ii) While employed by the Company and for three years after the Date of Termination (which may include the Compensation Continuance Period), the Executive will not become a director, officer, employee or consultant engaging in activities similar to those performed by a senior officer for any business which is in competition with any line of business of the Company or its affiliates and in which the Executive participated in a direct capacity while he was employed by the Company or its affiliates (including predecessors thereof) at any time within the one year period preceding the Effective Date and which has offices in any location in which the Executive had supervisory responsibility in the geographic footprint of First Union National Bank (or successors thereto, including but not limited to, Florida, Georgia, South Carolina, Tennessee, North Carolina, Virginia, Maryland, Pennsylvania, New Jersey, Delaware, New York, Connecticut, and Washington, D.C. plus any other state or states added during the Employment Period) during that one year period. The Executive expressly acknowledges the reasonableness of such restrictions and such geographic area. Further, during such period, the Executive will not acquire an equity or equity-like interest in such an organization for his own account, except that he may acquire equity interests of not more than 5% of any such organization from time to time as an investment. Notwithstanding anything to the contrary contained herein, this Section 7(b)(ii) shall not apply if the Executive terminates employment with the Company pursuant to Retirement or the Executive terminates employment with the Company for any reason following a Change in Control or the Company terminates the Executive’s employment for any reason following a Change in Control. Upon the Executive’s request to the Company’s Chief Executive Officer, the Company will provide an advance opinion as to whether a proposed activity would violate the provisions of this Section 7(b)(ii). (iii) During the Compensation Continuance Period, the Executive shall provide consulting services to the Company at such time or times as the Company shall reasonably request, subject to appropriate notice and to reimbursement by the Company of all reasonable travel and other expenses incurred and paid by the Executive in accordance with the Company’s then-current policy for expense reimbursement. In the event the Executive shall engage in any employment permitted hereunder during the Compensation Continuance Period for another employer or on a self-employed basis, the Executive’s obligation to provide the consulting services hereunder shall be adjusted in accordance with the requirements of such employment. (c) In the event of a breach or threatened breach of this Section 7, the Executive agrees that the Company shall be entitled to injunctive relief in a court of appropriate jurisdiction to remedy any such breach or threatened breach and, prior to
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a Change in Control, the Company may terminate the Compensation Continuance Period and the Compensation Continuance Benefits, if applicable, in its sole discretion. The Executive acknowledges that monetary damages would be inadequate and insufficient remedy for a breach or threatened breach of Section 7. Following the occurrence of a Change in Control, in no event shall an asserted violation of the provisions of this Section 7 constitute a basis for deferring or withholding any amounts otherwise payable to the Executive under this Agreement. If it is finally determined pursuant to the procedures set forth in this Agreement that the Executive did not breach this Section 7, the Company shall reimburse the Executive the amounts to which it is finally determined to be entitled. (d) Any termination of the Executive’s employment or of this Agreement shall have no effect on the continuing operation of this Section 7; provided, however, upon termination of this Agreement due to the Company’s or the Executive’s failure to extend the term of this Agreement pursuant to Section 1(b), Section 7(b)(ii) shall no longer apply to the Executive if the Executive’s employment shall terminate after the term of this Agreement expires; and provided, further, Section 7(b)(ii) shall not apply if the Executive terminates employment with the Company pursuant to Retirement or the Executive terminates employment with the Company for any reason following a Change in Control or the Company terminates the Executive’s employment for any reason following a Change in Control. (e) The Executive hereby agrees that prior to accepting employment with any other person or entity during the Employment Period or during the three years following the Date of Termination (which may include the Compensation Continuance Period), the Executive will provide such prospective employer with written notice of the existence of this Agreement and the provisions of Section 3(e) and this Section 7, with a copy of such notice delivered simultaneously to the Company in accordance with Section 11(c). The foregoing provision shall not apply if the Company terminates the Executive’s employment without Cause following a Change in Control, or if the Executive terminates his employment for Good Reason following a Change in Control. Anything in this 8. Certain Additional Payments by the Company. (a) Agreement to the contrary notwithstanding and except as set forth below, in the event it shall be determined that any payment or distribution by the Company to or for the benefit of the Executive following a Change in Control (whether paid or payable or distributed or distributable pursuant to the terms of the Agreement or otherwise, but determined without regard to any additional payments required under this Section 8) (a “Payment”) would be subject to the excise tax imposed by Section 4999 of the Code (or any successor statute) or any interest or penalties are incurred by the Executive with respect to such excise tax (such excise tax, together with any such interest and penalties, are hereinafter collectively referred to as the “Excise Tax”), then the Executive shall be entitled to receive an additional payment (a “Gross-Up Payment”) in an amount such that after payment by the Executive of all taxes (including any interest or penalties imposed with respect to such taxes), including, without limitation, any income taxes (and any interest and penalties imposed with respect thereto) and
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Excise Tax imposed upon the Gross-Up Payment, the Executive retains an amount of the Gross-Up Payment equal to the Excise Tax imposed upon the Payments. (b) Subject to the provisions of Section 8(c), all determinations required to be made under this Section 8, including whether and when a Gross-Up Payment is required and the amount of such Gross-Up Payment and the assumptions to be utilized in arriving at such determination, shall be made by KPMG LLP or such other certified public accounting firm reasonably acceptable to the Company (the “Accounting Firm”) which shall provide detailed supporting calculations both to the Company and the Executive within 30 business days of the receipt of notice from the Company that there has been a Payment, or such earlier time as is requested by the Company. All fees and expenses of the Accounting Firm shall be borne solely by the Company. Any Gross-Up Payment, as determined pursuant to this Section 8, shall be paid by the Company to the Executive by the due date for the payment of any Excise Tax, or, if earlier, 30 days after the receipt of the Accounting Firm’s determination. Any determination by the Accounting Firm shall be binding upon the Company and the Executive. As a result of the uncertainty in the application of Section 4999 of the Code at the time of the initial determination by the Accounting Firm hereunder, it is possible that Gross-Up Payments which will not have been made by the Company should have been made (“Underpayment”), consistent with the calculations required to be made hereunder. In the event that the Company exhausts its remedies pursuant to Section 8(c) and the Executive thereafter is required to make a payment of any Excise Tax, the Accounting Firm shall determine the amount of the Underpayment that has occurred and any such Underpayment shall be promptly paid by the Company to or for the benefit of the Executive. (c) The Executive shall notify the Company in writing of any claim by the Internal Revenue Service that, if successful, would require the payment by the Company of the Gross-Up Payment. Such notification shall be given as soon as practicable but no later than ten business days after the Executive is informed in writing of such claim and shall apprise the Company of the nature of such claim and the date on which such claim is requested to be paid. The Executive shall not pay such claim prior to the expiration of the 30-day period following the date on which it gives such notice to the Company (or such shorter period ending on the date that any payment of taxes with respect to such claim is due). If the Company notifies the Executive in writing prior to the expiration of such period that it desires to contest such claim, the Executive shall: (i) give the Company any information reasonably requested by the Company relating to such claim, (ii) take such action in connection with contesting such claim as the Company shall reasonably request in writing from time to time, including, without limitation, accepting legal representation with respect to such claim by an attorney reasonably selected by the Company, (iii) cooperate with the Company in good faith in order to
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effectively contest such claim, and (iv) permit the Company to participate in any proceedings relating to such claim; provided, however, that the Company shall bear and pay directly all costs and expenses (including additional interest and penalties) incurred in connection with such contest and shall indemnify and hold the Executive harmless, on an after-tax basis, for any Excise Tax or income tax (including interest and penalties with respect thereto) imposed as a result of such representation and payment of costs and expenses. Without limitation on the foregoing provisions of this Section 8(c), the Company shall control all proceedings taken in connection with such contest and, at its sole option, may pursue or forego any and all administrative appeals, proceedings, hearings and conferences with the taxing authority in respect of such claim and may, at its sole option, either direct the Executive to pay the tax claimed and sue for a refund or contest the claim in any permissible manner, and the Executive agrees to prosecute such contest to a determination before any administrative tribunal, in a court of initial jurisdiction and in one or more appellate courts, as the Company shall determine; provided, however, that if the Company directs the Executive to pay such claim and sue for a refund, the Company shall advance the amount of such payment to the Executive, on an interest-free basis and shall indemnify and hold the Executive harmless, on an after-tax basis, from any Excise Tax or income tax (including interest or penalties with respect thereto) imposed with respect to such advance or with respect to any imputed income with respect to such advance; and further provided that any extension of the statute of limitations relating to payment of taxes for the taxable year of the Executive with respect to which such contested amount is claimed to be due is limited solely to such contested amount. Furthermore, the Company’s control of the contest shall be limited to issues with respect to which a Gross-Up Payment would be payable hereunder and the Executive shall be entitled to settle or contest, as the case may be, any other issue raised by the Internal Revenue Service or any other taxing authority. (d) If, after the receipt of an amount advanced by the Company pursuant to Section 8(c), the Executive becomes entitled to receive any refund with respect to such claim, the Executive shall (subject to the Company’s complying with the requirements of Section 8(c)) promptly pay to the Company the amount of such refund (together with any interest paid or credited thereon after taxes applicable thereto) upon receipt thereof. If, after the receipt by the Executive of an amount advanced by the Company pursuant to Section 8(c), a determination is made that the Executive shall not be entitled to any refund with respect to such claim and the Company does not notify the Executive in writing of its intent to contest such denial or refund prior to the expiration of 30 days after such determination, then such advance shall be forgiven and shall not be required to be repaid and the amount of such advance shall offset, to the extent thereof, the amount of Gross-Up Payment required to be paid. (e)
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For purposes of this Section 8, any reference to the Executive shall
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be deemed to include the Executive’s surviving spouse, estate and/or beneficiaries with respect to payments or adjustments provided by this Section 8. 9. Successors. (a) This Agreement is personal to the Executive and without the prior consent of the Company shall not be assignable by the Executive otherwise than by will or the laws of descent and distribution. (b) This Agreement shall inure to the benefit of and be binding upon the Company and its successors and assigns. (c) The Company will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company to assume expressly in writing and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession had taken place. As used in this Agreement, “Company” shall mean the Company as hereinbefore defined and any successor to its business and/or assets as aforesaid which assumes and agrees to perform this Agreement by operation of law, or otherwise. 10. Arbitration. Except with respect to the Company’s rights to injunctive relief for matters arising under Section 7 of this Agreement, any disputes or controversies arising under or in connection with this Agreement (including, without limitation, whether any such disputes or controversies have been brought in bad faith) shall be settled exclusively by arbitration in Charlotte, North Carolina in accordance with the commercial arbitration rules of the American Arbitration Association then in effect; provided, however, that the Company may invoke the American Arbitration Association’s Optional Rules for Emergency Measures of Protection. Judgment may be entered on the arbitrator’s award in any court having jurisdiction. 11. General Provisions. (a) Governing Law; Amendment; Modification. This Agreement shall be governed and construed in accordance with the laws of the State of North Carolina, without reference to principles of conflict of laws. This Agreement may not be modified or amended except by an instrument in writing signed by the parties hereto. (b) Severability. If, for any reason, any provision of this Agreement is held invalid, such invalidity shall not affect any other provision of this Agreement not held so invalid, and each such other provision shall to the full extent consistent with law continue in full force and effect. If any provision of this Agreement shall be held invalid in part, such invalidity shall in no way affect the rest of such provision not held so invalid and the rest of such provision, together with all other provisions of this Agreement, shall to the full extent consistent with law continue in full force and effect. (c) Notices. All notices under this Agreement shall be in writing and shall be deemed effective when delivered in person (in the Company's case, to its Secretary) or forty-eight (48) hours after deposit thereof in the U.S. mail, postage prepaid, for delivery as registered or certified mail -- addressed, in the case of the
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Executive, to such Executive at his residential address, and in the case of the Company, to its corporate headquarters, attention of the Secretary, or to such other address as the Executive or the Company may designate in writing at any time or from time to time to the other party. In lieu of notice by deposit in the U.S. mail, a party may give notice by telegram or telex. (d) Tax Withholding. The Company may withhold from any amounts payable under this Agreement such Federal, state, local or foreign taxes as shall be required to be withheld pursuant to any applicable law or regulation. (e) Strict Compliance. The Executive’s or the Company’s failure to insist upon strict compliance with any provision of this Agreement or the failure to assert any right the Executive or the Company may have hereunder, including, without limitation, the right of the Executive to terminate employment for Good Reason pursuant to Section 3(c) of this Agreement, shall not be deemed to be a waiver of such provision or right or any other provision or right of this Agreement. The waiver, whether express or implied, by either party of a violation of any of the provisions of this Agreement shall not operate or be construed as a waiver of any subsequent violation of any such provision. (f) Entire Understanding. From and after the Effective Date this Agreement shall supersede any other agreement between the parties with respect to the subject matter hereof, including without limitation, the Employment Agreement between the Company (as successor to the former Wachovia Corporation) and the Executive dated as of October 22, 1999, but excluding, except as provided herein, the SERP Agreement. (g) Conflicts with Plans. To the extent any plan, policy, practice or program of or contract or agreement with the Company attempts to cap, restrict, limit or reduce payments to the Executive hereunder, such caps, restrictions, limitations or reductions are expressly modified to permit the payments contemplated hereby and the parties intend that the terms of this Agreement shall be construed as having precedence over any such caps, restrictions, limitations or reductions. (h) Release and Waiver of Claims. In consideration of any Compensation Continuance Benefits the Company provides to the Executive under this Agreement, the Executive upon termination of employment with the Company shall execute a separate general release and waiver of claims in favor of the Company, its affiliates and personnel in a form acceptable to the Company. The Executive shall not be eligible for any Compensation Continuance Benefits until the Executive has executed such release and waiver of claims. (i) Creditor Status. No benefit or promise hereunder shall be secured by any specific assets of the Company. The Executive shall have only the rights of an unsecured general creditor of the Company in seeking satisfaction of such benefits or promises.
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(j) No Assignment of Benefits. No right, benefit or interest hereunder shall be subject to assignment, encumbrance, charge, pledge, hypothecation or set off in respect of any claim, debt or obligation, or similar process. (k) SERP Agreement. Sections 2(b)(vi) and 4(a)(viii) of this Agreement constitute an amendment to the SERP Agreement. All provisions in the SERP Agreement not affected by such amendment shall remain in full force and effect.
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IN WITNESS WHEREOF, the Company has caused this Agreement to be executed by its officers thereunto duly authorized, and the Executive has signed this Agreement under seal, all as of the date and year first above written. WACHOVIA CORPORATION ATTEST: [SEAL]
By:_________________________ Name: G. Kennedy Thompson Title: Chief Executive Officer
____________________________ Mark C. Treanor Secretary
__________________________ (SEAL) Jean E. Davis
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Exhibit (10)(p) June 22, 2004
Ms. Jean E. Davis [Address] Charlotte, NC [zip code] Re: Employment Agreement Dear Jean, As we discussed, I want to clarify certain matters related to your employment agreement. As you know, your employment agreement with Wachovia provides you with the option to make “Good Reason” termination of your employment with Wachovia for any reason during the period from January 1, 2004 to June 30, 2004. The Management Resources and Compensation Committee at its April 19, 2004 meeting approved modifying your agreement to provide you with the option to make a “Good Reason” termination of your employment with Wachovia for any reason during the period from January 1, 2006 to March 31, 2006. In addition, I am pleased to advise you that you have been awarded a stock option grant on 36,256 shares with a stock price of $45.02 and a restricted stock award of 9,789 shares. Very truly yours,
G. Kennedy Thompson
cc:
Paul George Chuck Loring
Exhibit (10)(s) AMENDMENT NO. 2 TO EMPLOYMENT AGREEMENT This Amendment No. 2 dated December 20, 2005 (the “Amendment”), to the Employment Agreement dated November 1, 2001 and amended as of June 22, 2004 (as amended, the “Employment Agreement”) made and entered into by and between Wachovia Corporation (the “Corporation”) and Jean E. Davis (the “Executive”); RECITALS WHEREAS, Section 409A of the Internal Revenue Code (as amended, the “Code”) requires delayed commencement of payments to “key employees” in order to avoid a prohibited payment under Code Section 409A(a)(2); WHEREAS, the Executive has been and it is contemplated that the Executive will continue to be designated as a “key employee” of the Corporation as that term is defined under Code Section 416(i); WHEREAS, the Corporation and the Executive desire to amend the Employment Agreement in order to comply with the requirements of Code Section 409A and the rules promulgated thereunder and provide for a Code Section 409A(a)(2) deferral period as necessary to avoid a prohibited payment and prevent any imposition of certain tax penalties on the Executive; NOW, THEREFORE, the Corporation and Executive mutually agree as follows: 1. The following new Section 4(f) is added immediately following Section 4(e):
“(f) Delayed Payment Date. Notwithstanding any provision to the contrary in this Agreement, if the Executive is deemed at the time to be a “key employee” within the meaning of that term under Internal Revenue Code Section 416(i) and such delayed commencement is otherwise required in order to avoid a prohibited distribution under Internal Revenue Code Section 409A(a)(2), no payments or benefits to which the Executive otherwise becomes entitled under this Agreement shall be made or provided to the Executive prior to the earlier of (i) the expiration of the six (6)-month period measured from the date of the Executive’s “separation from service” (as such term is defined in Treasury Regulations issued under Internal Revenue Code Section 409A) or (ii) the date of the Executive’s death. Upon the expiration of the applicable Internal Revenue Code Section 409A(a)(2) deferral period referred to in the preceding sentence, all payments and benefits deferred pursuant to this Section 4(f) (whether they would have otherwise been payable in a single sum or in installments in the absence of such deferral) shall be paid or reimbursed to the Executive in a lump sum, and any remaining payments and benefits due under this Agreement shall be paid or provided in accordance with the normal payment dates specified for them herein.” 2. This Amendment constitutes an amendment to the Employment Agreement pursuant to Section 11(a) of the Employment Agreement. All provisions of the Employment Agreement not affected by this Amendment shall remain in full force and effect and shall continue to be binding obligations of both parties hereto. Capitalized terms used in this Amendment but not defined herein shall have the meanings assigned thereto in the Employment Agreement.
3. This Amendment may be executed in any number of counterparts and each of such counterparts shall for all purposes be deemed to be an original, and all such counterparts shall together constitute but one and the same instrument. [Signatures appear on following page.]
IN WITNESS WHEREOF, the Corporation has caused this Amendment to the Employment Agreement to be executed and delivered by its duly authorized officer, and the Executive has executed and delivered this Amendment to the Employment Agreement as of the date written above. WACHOVIA CORPORATION ATTEST: [SEAL]
By: /s/ G. Kennedy Thompson Name: G. Kennedy Thompson Title: Chief Executive Officer
/s/ Mark C. Treanor Mark C. Treanor Secretary
EXECUTIVE
/s/ Jean E. Davis Jean E. Davis
(SEAL)
Exhibit (10)(x) AMENDMENT NO. 1 TO SENIOR EXECUTIVE RETIREMENT AGREEMENT THIS AMENDMENT NO. 1, made and entered into as of October 31, 2001 by and between Wachovia Corporation, a North Carolina corporation (the “Company”) and Jean E. Davis (the “Executive”); WHEREAS, the Company and the Executive have entered into the senior executive retirement agreement dated October 22, 1999 (the “Agreement”) pursuant to which the Executive is entitled to certain supplemental retirement benefits as provided in the Agreement; WHEREAS, the Company and the Executive desire to enter into an employment agreement dated as of November 1, 2001 (the “New Employment Agreement”) that will supercede the employment agreement dated October 22, 1999 (the “Old Employment Agreement”) between the Company and the Executive; and WHEREAS, the Company and the Executive desire to amend the Agreement and confirm certain matters pertaining to the Agreement as a result of the replacement of the Old Employment Agreement by the new Employment Agreement, NOW, THEREFORE, in consideration of these premises and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows: 1. Definitions. All terms defined in the Agreement are used in this Amendment as therein defined unless specifically defined in this Amendment. From and after the effectiveness of the New Employment Agreement, the following definitions shall apply for the purposes of the Agreement: (a) The term “Change of Control” shall have the meaning assigned to such term in the New Employment Agreement. (b) The term “Compensation Period” shall have the meaning assigned to the term “Compensation Continuance Period” in the New Employment Agreement. (c) The term “Continuation Benefits” shall have the meaning assigned to the term “Compensation Continuance Benefits in the new Employment Agreement. 2. Change of Control. The parties agree that a “Change of Control” occurred within the meaning of the Agreement prior to the execution of this Amendment No. 1 and the New Employment Agreement. Accordingly, the parties hereby confirm that: (a) Pursuant to the third sentence of Section 7(a) of the Agreement, the Executive is vested in the right to receive payment of the Supplemental Benefit under and
determined in accordance with the provisions of the Agreement and clauses (i) and (ii) of the first sentence of Section 7(a) are no longer applicable. (b) Pursuant to the second sentence of Section 7(i) of the Agreement, the Agreement may not be amended or terminated without the express written consent of the Executive. 3. Binding Effect. The Agreement shall continue in full force and effect as amended hereby and, upon the effectiveness of the New Employment Agreement, as provided in the New Employment Agreement. IN WITNESS WHEREOF, the Company has caused this Amendment to be executed by its officers thereunto duly authorized, and the Executive has signed this Amendment under seal, all as of the date and year first above written. WACHOVIA CORPORATION ATTEST: [SEAL]
By: /s/ G. Kennedy Thompson Name: G. Kennedy Thompson Title: Chief Executive Officer
/s/ Mark C. Treanor Mark C. Treanor Secretary
/s/ Jean E. Davis Jean E. Davis
(SEAL)
Exhibit (10)(pp) SPLIT-DOLLAR LIFE INSURANCE TERMINATION AGREEMENT, dated as of December 29, 2003 (this “Agreement”), among WACHOVIA CORPORATION, a North Carolina corporation, its subsidiaries and affiliates (the “Corporation”), Jean E. Davis (the “Insured”) and The Jean E. Davis Irrevocable Living Trust dated September 20, 2000 (the “Owner”). WITNESSETH: WHEREAS, the Corporation, the Insured and the Owner desire to terminate the Split-Dollar Life Insurance Agreement among them; and WHEREAS, as a condition to and together with the parties executing this Agreement, Wachovia Corporation (“Wachovia”), the Insured and the Owner are executing an Insurance Bonus Agreement, dated the same date as this Agreement (the “Insurance Bonus Agreement”); NOW, THEREFORE, in consideration of the mutual promises made herein, the parties agree as follows: 1. Termination of the Agreement. The Split-Dollar Life Insurance Agreement, dated as of September 20, 2000, among the Corporation, the Insured and the Owner (the “Split-Dollar Agreement”) is hereby terminated. The Insured and the Owner authorize the Corporation, Wachovia and their respective representatives to take all actions necessary to effectuate the termination. 2. Repayment of the Corporation’s Interest and Investment in a New Policy. The Corporation shall promptly recover all amounts owed it under the Split-Dollar Agreement and the arrangements contemplated by it. Upon receipt by the Corporation of the entire amount owed it, the Owner directs the Corporation, Wachovia and their respective representatives to surrender and/or cancel the insurance policy or policies underlying the Split-Dollar Agreement and apply the Owner’s portion of any value resulting therefrom (after withholding for income taxes) toward the Policy referred to in the Insurance Bonus Agreement. 3. Full Cooperation. The Insured and the Owner shall cooperate fully with the Corporation, Wachovia and the Insurer (as defined in the Split-Dollar Agreement) and take all actions (including but not limited to transferring possession of the underlying insurance policy to the Corporation, or surrendering or canceling the policy to pay the Corporation the amount owed it from the cash value) to the extent reasonably necessary to ensure that the Corporation promptly recovers the amounts owed it under the Split-Dollar Agreement and any excess value in the underlying insurance policy is applied as set forth in Section 2. 4. Liability of the Company. Neither Wachovia nor the Corporation makes any representations or shall have any responsibility or liability for any tax or estate planning matters with respect to the termination of the Split-Dollar
Agreement. Wachovia has encouraged the Insured and the Owner to consult tax and legal advisors, and the Insured and the Owner have relied on their own tax and legal advisors with respect to this decision to terminate. IN WITNESS WHEREOF, the parties hereto have executed this Split-Dollar Life Insurance Termination Agreement on the date first above written. WACHOVIA CORPORATION By: __________________________________ Name: Charles D. Loring Title: Senior Vice President
Insured
Owner
________________________________________ By: ________________________________ Insured: Jean E. Davis Trustee: Wachovia Bank, N.A. Owner: The Jean E. Davis Irrevocable Living Trust dated September 20, 2000 Date: _________________________, 2003 Date: _______________________, 2003
2
Exhibit(10)(qq) INSURANCE BONUS AGREEMENT (the “Agreement”), dated as of December 29, 2003, among WACHOVIA CORPORATION, a North Carolina corporation, its subsidiaries and affiliates (the “Company”), Jean E. Davis (the “Insured”) and The Jean E. Davis Irrevocable Living Trust dated September 20, 2000 (the “Owner”). W I T N E S S E T H: WHEREAS, the Owner desires to purchase a life insurance policy insuring the life of the Insured; WHEREAS, the Company desires to provide the Insured with a special bonus for work performed for the Company; and WHEREAS, the Company, the Insured and the Owner desire to terminate the SplitDollar Life Insurance Agreement among them and this Agreement is a condition to the termination; NOW, THEREFORE, in consideration of the preceding and the mutual promises made herein, the Company and the Insured agree as follows: 1. Purchase Of Policy. The Owner agrees that it shall apply to The Travelers Insurance Company (together, the “Insurer”) for a policy of insurance having the terms set forth in the attached Schedule (the “Policy”). The Insured agrees to provide any and all information requested by the Insurer in order for the Insurer to underwrite the Policy, including but not limited to a medical examination and completion of forms as requested by the Insurer. 2. Policy Ownership. The Owner shall be the sole owner of the Policy and shall have all incidents of ownership in and to the Policy. 3. Insurance Bonus. In addition to any and all compensation paid by the Company to the Insured for the Insured’s services, the Company shall cause an annual insurance bonus to be paid to the Insured (or after the Insured’s death, to his or her surviving spouse) in the amount of Sixty Four Thousand, One Hundred Twenty-Five Dollars ($64,125.00) (the “Insurance Bonus”). While this Agreement is in force, the Insurance Bonus will be paid during December each year, beginning 2003. The parties agree that the Insurance Bonus is compensation for services and that the Company may withhold any taxes that are required to be withheld under any law, rule or regulation. 4. Premium Payments. The Owner agrees to pay the annual premium on the Policy (the “Annual Premium”) when due. As a convenience to the Insured and the Owner, the Insured directs the Company (a) to pay the Insurance Bonus directly to the Insurer on behalf of the Owner against the Annual Premium and (b) to the extent the Annual Premium exceeds the amount of the Insurance Bonus after all applicable withholding, to pay the excess out of the amount of any other compensation then owed to
the Insured. The Company shall notify the Insured of any amounts it has paid under this Section 4, and the Owner shall pay any remainder of the Annual Premium when due. For the avoidance of doubt, this Agreement in no way obligates the Company to extend or maintain credit to or for the Insured or the Owner. 5. Termination. This Agreement shall terminate upon the earlier of: (a) The later of the death of the Insured or the Insured’s spouse;
(b) Written notice by the Company to the Insured, if the Owner has failed to pay any portion of the Annual Premium when due or either the Owner or the Insured has failed to comply with any other provision of this Agreement (and, in each case, such failure has not been cured within 30-days of the Company’s written notice to the Insured); (c) Mutual agreement by the Company and the Insured.
Termination of Insured’s employment with the Company and its subsidiaries shall not affect the party’s obligations under this Agreement. 6. Certain Forbearances. Notwithstanding Section 2 of this Agreement, the Owner agrees that during the term of this Agreement that the Owner will not (without the prior written consent of the Company): (a) exchange or surrender any part of the Policy (for its cash value or otherwise); (b) obtain a loan against the Policy from the Insurer; (c) assign any part of the Policy as collateral security; (d) change the ownership of any part of the Policy by endorsement or assignment; or (e) request a settlement of the proceeds of the Policy under any method of settlement other than one which is in reference to the life of the Insured. If applicable, the Owner shall enter into an agreement with the Insurer to effect the foregoing. 7. Amendment Of Agreement. The Agreement shall not be amended, altered or modified, and no term may be waived, without the written agreement of the Insured and the Company. The agreement of the Owner shall not be required unless the amendment, alteration, modification or waiver increases materially the obligations of the Owner under this Agreement. The failure of the Company to enforce any of the provisions of this Agreement shall in no way be construed to be a waiver of any such provision. No waiver of any breach of this Agreement shall be held to be a waiver of any other or subsequent breach. 8. Death Benefits. The Owner shall designate the beneficiary or beneficiaries of the Policy, and the Company shall have no rights or interest in the death proceeds payable under the Policy or in the cash value of the Policy. 9. Miscellaneous. The Company and the Insured agree that (a) this Agreement is not and shall not be construed as an employee benefit plan subject to the
2
Employment Retirement Income Security Act of 1974, as amended (“ERISA”) and (b) the value of the Insured’s Insurance Bonus shall not be considered as salary or compensation for purposes of determining the Insured’s benefits under any of the Company’s or its affiliates’ plans, policies or arrangements, including, but not limited to, pension, retirement, profit sharing, bonus or severance plans or under any agreement between the Insured and the Company or one of its affiliates. Before making any claim under this Agreement, the Owner and the Insured will comply with the Company’s claims procedures, which may be obtained from the Company’s Executive Compensation Department. This agreement shall be subject to and construed under the laws of the state of North Carolina. 10. Use of Certain Definitions. Capitalized terms used herein but not defined herein shall have the meanings ascribed to such terms in the Employment Agreement, dated as of November 1, 2001(the “Employment Agreement”), by and between the Insured and the Company. This Agreement does not constitute an amendment to the Employment Agreement. 11. Liability Of Insurer. The Insurer is not a party to this Agreement and shall have no liability except as set forth in the Policy. 12. Liability Of the Company. The Company makes no representations to the Insured and shall have no responsibility or liability for the tax effects of this Insurance Bonus Agreement or any related payments under the Policy. The Insured is solely responsible for any taxes owed as a result of the Insurance Bonus. The Owner and the Insured represent that they have relied on their own tax and legal advisors with respect to this Agreement, the Insurance Bonus and the Policy. 13. No Third Party Beneficiaries. This Agreement shall not confer any rights or remedies on any person other than the Company, the Insured or the Owner.
3
IN WITNESS WHEREOF, the parties hereto have executed this Insurance Bonus Agreement on the date first above written.
WACHOVIA CORPORATION
By: ____________________________ Name: Charles D. Loring Title: Senior Vice President Date: ______________________, 2003
______________________________ Insured: Jean E. Davis Date: ______________________, 2003
______________________________ Trustee: Wachovia Bank, N.A. Owner: The Jean E. Davis Irrevocable Living Trust dated September 20, 2000 Date: ______________________, 2003
4
Exhibit (10) (jjj)
First Union Corporation Benefit Restoration Plan (Effective December 31, 1993) As amended and Restated April 20, 1999
1
First Union Corporation Benefit Restoration Plan (Effective December 31, 1993) Table of Contents Section I. The Plan 1.1 1.2 1.3 Establishment of the Plan Purpose of the Plan Application of the Plan
Section II. Definitions 2.1 2.2 2.3 2.4 2.5 2.6 2.7 2.8 2.9 2.10 2.11 2.12 2.13 2.14 2.15 2.16 2.17 2.18 2.19 2.20 2.21 2.22 2.23 2.24 2.25 2.26 2.27 2.28 Actuarial Equivalent Affiliate Applicable Federal Rate Beneficiary Benefit Commencement Date Board Cause Change of Control Code Company Disability Earliest Retirement Age Employee Employer ERISA Lump Sum Actuarial Equivalent Normal Retirement Date Participant Pension Plan Plan Plan Administrator Plan Change Plan Termination Plan Year Present Value Service Termination of Service Years of Service
Section III. Participation 3.1 3.2 Eligibility Duration
2
First Union Corporation Benefit Restoration Plan (Effective December 31, 1993) Table of Contents (Continued) Section IV. Benefits 4.1 4.2 4.3 4.4 4.5 4.6 Retirement Benefits Disability Retirement Benefits Termination Benefit Form of Payment Payments in the Event of Plan Termination, Plan Change or Change in Control Payments upon a Participant's Termination for Cause.
Section V. Preretirement Death Benefits 5.1 5.2 5.3 Eligibility Amount Commencement
Section VI. Financing 6.1 6.2 6.3 Financing No Trust Created Unsecured Interest
Section VII. Administration 7.1 7.2 7.3 7.4 7.5 7.6 Administration Appeals from Denial of Claims Tax Withholding Expenses Actuarial Equivalence Liability of the Plan Administrators; Indemnification
Section VIII. Adoption of the Plan by Affiliate 8.1 8.2 Adoption of the Plan by Affiliate Amendment and Termination of the Plan
Section IX. Miscellaneous Provisions 9.1 9.2 9.3 No Contract of Employment Severability Applicable Law 3
First Union Corporation Benefit Restoration Plan (Effective December 31, 1993)
Section I. Establishment and Purpose 1.1 Establishment of the Plan. First Union Corporation (the "Company") hereby establishes this supplemental retirement plan for eligible employees of the Company and participating Affiliates, effective as of December 31, 1993. This plan shall be known as the "First Union Corporation Benefit Restoration Plan" (hereinafter called the "Plan"). 1.2 Purpose of the Plan. The Plan is intended to restore benefits that are curtailed as a result of legal limits that apply to the First Union Corporation Pension Plan and Trust. The portion of the Plan which restores benefits affected by the limits described in Code section 415 is intended to be an "excess benefit plan" as defined in ERISA section 3 (36). The portion of the Plan which restores benefits affected by the compensation limit described in Code section 401 (a) (17) is intended to be a plan maintained for the purpose of providing deferred compensation to a "select group of management or highly compensated employees." 1.3 Application of the Plan. The Plan applies only to eligible Employees who are in the active employ of the Company or a participating Affiliate on or after December 31, 1993.
4
Section II. Definitions Whenever used hereinafter, the following terms shall have the meanings set forth below unless otherwise expressly provided. When the defined meaning is intended, the term is capitalized. The definition of any term in the singular shall also include the plural and any masculine terminology shall be deemed to refer to either a male or female. 2.1 "Actuarial Equivalent" means a benefit having the same value as the benefit which it replaces, computed on the bases of the actuarial equivalence assumptions in effect under the Pension Plan. 2.2 (a) "Affiliate" means-any corporation while it is a member of the same "controlled group" of corporations (within the meaning of Code section 414 (b)) as the Company; any other trade or business (whether or not incorporated) while it is under "common control" (within the meaning of Code section 414(c)) with the Company; and any organization during any period in which it (along with the Company) is a member of an "affiliated service group" (within the meaning of Code section 414 (m)); or any other entity during any period in which it is required to be aggregated with the Company under Code section 414 (o).
(b)
(c)
2.3 "Applicable Federal Rate" means the interest rate provided for under Section 1274 (d) of the Internal Revenue Code in effect as of (i) the date of a Change of Control, or if elected in writing by the Company and a Participant, at the time a Participant becomes a Participant, (ii) the later of (a) December 31, 1993 or (b) the date an individual becomes a Participant pursuant to Section 3.2. 2.4 "Beneficiary" means the individual designated by the Participant to receive any death benefits payable on the Participant's behalf under the Pension Plan. 2.5 "Benefit Commencement Date" means the date on which a Participant's benefits shall commence under Section IV. Except as otherwise provided under section 4.2, a Participant's Benefit Commencement Date shall be the first day of the month next following the later of -(a) (b) 2.6 the Participant's Termination of Service; or the date on which the Participant attains his or her Earliest Retirement Age. "Board" means the board of directors of the Company.
5
2.7 "Cause" means an act or acts of a Participant's personal dishonesty, incompetence, willful misconduct, breach of fiduciary duty involving personal profit, intentional failure to perform stated duties, willful violation of any law, rule, or regulation (other than traffic violations or similar offenses) or final cease-and-desist order. For purposes of this definition, no act, or failure to act, on a Participant's part shall be considered "willful" unless done, or omitted to be done, by him not in good faith and without reasonable belief that his action or omission was in the best interest of the Company. 2.8 "Change of Control" means a change in control of the Company of a nature that would be required to be reported in response to item 6(e) of Schedule 14A of Regulation 14A promulgated under the Securities Exchange Act of 1934, as amended ("Exchange Act"); provided that, without limitation, such a change in control shall be deemed to have occurred if (i) any one person, or more than one person acting as a group, acquires ownership of stock of a corporation that, together with stock held by such person or group, possesses more than 50 percent of the total fair market value or total voting power of the stock of such corporation, or (ii) any one person, or more than one person acting as a group, acquires (or has acquired during 12-month period ending on the date of the most recent acquisition by such person or persons) ownership of stock of a corporation possessing 20 percent or more of the total voting power of the stock of such corporation, or (iii) a majority of members of the corporation's board of directors is replaced during any 12-month period by directors whose appointment or election is not endorsed by a majority of the members of a corporation's board of directors prior to the date of the appointment or election. 2.9 "Code" means the Internal Revenue Code of 1986, as amended, or as it may be amended from time to time. A reference to a particular section of the Code shall also be deemed to refer to any regulations under that section. 2.10 "Company" means First Union Corporation and any successor thereto that agrees to adopt and continue the Plan. 2.11 "Disability" means any physical or mental condition which would result in the Participant incurring a "Disability" under disability provisions contained in the Pension Plan. 2.12 "Earliest Retirement Age" means the earliest date on which a Participant could retire and elect to commence benefits under the Pension Plan. 2.13 "Employee" means any person who is employed by an Employer.
2.14 "Employer" means the Company and each Affiliate which has adopted the Plan for the benefit of its eligible Employees. 2.15 "ERISA" means the Employee Retirement Income Security Act of 1974, as amended, or as it may be amended from time to time. A reference to a particular section of ERISA shall also be deemed to refer to the regulations under that section. 2.16 "Lump Sum Actuarial Equivalent" means a single payment which is actuarially equivalent to the annuity benefit due a Participant under the Plan computed using the most recent Pension Benefit Guarantee Corporation discount rate in effect for the Company's Pension Plan and the mortality assumptions utilized in the most recent actuarial valuation for the Company's Pension Plan. 6
2.17 "Normal Retirement Date" means the first day of the month next following the later of the-(a) (b) participation Participant's sixty-fifth birthday; or the fifth anniversary of the date on which the Participant commenced under the Pension Plan.
2.18 "Participant" means an Employee who has met, and continues to meet, the eligibility requirements of section 3.1. 2.19 "Pension Plan" means the First Union Corporation Pension Plan and Trust, as amended from time to time. 2.20 "Plan" means this First Union Corporation Benefit Restoration Plan.
2.21 "Plan Administrator" means the Company's Chief Executive Officer and the Company's Human Resources Division Head. 2.22 "Plan Change" means any modification to the Plan which would cause the actual or projected benefit to be or being paid to any or all persons who were Participants, or beneficiaries of Participants, on the day before the Plan Change, to be reduced. 2.23 "Plan Termination" means any modification to the Plan which would cause no benefit to be paid to any or all persons who were Participants, or beneficiaries of Participants, on the day before the Plan Termination. 2.24 "Plan Year" means the calendar year.
2.25 "Present Value" means the present value of a payment or payments computed using an interest rate equal to 1.2 times the Applicable Federal Rate (compounded semiannually) and the number of Years, including any fraction thereof, by which the date of a Plan Termination or Plan Change precedes the Participant's attainment of his Early Retirement Age. 2.26 "Service" means a Participant's aggregate elapsed time, in Years of Service, as an Employee of the Company from his initial date of hire to the earlier to occur of his termination of employment or his Normal Retirement Date. 2.27 "Termination of Service" means an Employee's death or resignation, discharge or retirement from the Company and its Affiliates. 2.28 ”Year" means the 12 month period beginning January 1 and ending December 31.
2.29 "Years of Service" shall have the same meaning assigned to such term in the Corporation's Pension Plan.
7
Section III. Participation 3.1 Eligibility. An Employee shall become a Participant as of the date he or she is designated by the Plan Administrator, in its sole discretion, as eligible to participate in the Plan. Participation in that part of the Plan which restores Pension Plan benefits that are curtailed under the compensation limit in effect under Code section 401(a) (17) shall be limited to Employees who are members of a "select group of management or highly compensated employees" within the meaning of ERISA section 201(2); provided however, an Employee who participates in the First Union Corporation Supplemental Retirement Plan shall not be eligible to participate in the Plan. 3.2 Duration. An Employee who becomes a Participant under Section 3.1 shall remain an active Participant until the earlier of -(a) his or her termination of service; or (b) a determination by the Plan Administrator that he or she is no longer eligible to participate in the Plan. An individual whose active participation is terminated under this section 3.2(a) shall continue to be an inactive Participant until all benefits to which he or she is entitled to under the Plan have been paid.
8
Section IV. 4.1 Retirement Benefits.
Benefits
A Participant who has a vested interest in a retirement benefit under the (a) Eligibility. Pension Plan shall be eligible for a retirement benefit under this section 4.1. Except as otherwise provided in section 4.4, the normal retirement benefit shall be calculated as a single life annuity commencing on the Participant's Normal Retirement Date. However, if the Participants' Benefit Commencement Date precedes his or her Normal Retirement Date, the benefit determined under this section 4.1 shall be reduced in accordance with section 4.1 (b) (2). (b) Amount. (1) In General. Subject to paragraph (2) below, a Participant who is eligible for a retirement benefit under subsection (a) shall be entitled to a monthly benefit equal to the difference between (A) and (B) where -(A) is the benefit the Participant would be entitled to under the Pension Plan of his or her Normal Retirement Date, calculated without regard to -(i) the compensation limit in effect under Code section 401(a)(17); and the benefit limit in effect under Code section 415; and
(ii) (B)
is the benefit payable to the Participant under the Pension Plan as of his or her Normal Retirement Date.
(2)
Early Commencement. In the case of a Participant whose Benefit Commencement Date precedes his or her Normal Retirement Date, the monthly benefit determined under paragraph (1) shall be reduced for early commencement in the same manner and amount as an early retirement benefit payable under the Pension Plan. Other Benefits. If a Participant is due a benefit under a plan listed on Schedule A which is maintained by the Employer the benefit hereunder will be decreased by the benefit provided under the plan listed on Schedule A.
(3)
4.2 Disability Retirement Benefits. (a) Eligibility. A Participant who incurs a Termination of Service on account of Disability, and who is eligible for a disability retirement benefit under the Pension Plan, shall be eligible for a disability retirement benefit under the Plan. Except as otherwise provided in Section 4.4, the disability benefit shall be calculated and paid as a single life annuity commencing on the Participant's Normal Retirement Date. b) Amount. A disabled Participant who is eligible for a disability retirement benefit under subsection (a) shall be entitled to a monthly retirement benefit equal to the difference 9
between (1) and (2) where -(1) is the disability retirement benefit the Participant is entitled to under the Pension Plan at his or her Normal Retirement Date, but calculated without regard to the limits described in section 4.1 (b) (1) (A); and is the disability benefit actually payable to the Participant under the Pension Plan as of his or her Normal Retirement Date.
(2)
(c)
Other Benefits. If a Participant is due a benefit under a plan listed on Schedule A which is maintained by the Employer the benefit hereunder will be decreased by the benefit provided under the plan listed on Schedule A. Termination Benefit. (a) Eligibility. A participant whose employment with the Company terminates (for reasons other than Cause, death or long-term disability) on or after he has completed ten Years of Service and before his Earliest Retirement Age shall be eligible for a termination benefit under the Plan. (b) Amount. A Participant who is eligible pursuant to (a) above shall be entitled to a monthly termination benefit computed in the same manner as an early retirement benefit under section 4.1(b) (2) hereof, based upon his Service at termination and assuming that he attained his Earliest Retirement Age on the day before his termination; provided, however, such amount shall be actuarially reduced for early payment. (c) Commencement and Duration. Monthly termination benefit payments shall commence upon a Participant's attainment of his Earliest Retirement Age. When payments begin, they shall be paid monthly thereafter as one of the scheduled paydays of each succeeding month during his lifetime. (d) Other Benefits. If a Participant is due a benefit under a plan listed on Schedule A which is maintained by the Employer the benefit hereunder will be decreased by the benefit provided under the plan listed on Schedule A.
4.3
4.4 (a)
Form of Payment. Unmarried Participant. The form of payment for a Participant who is not married on his or her Benefit Commencement Date shall be a single life annuity. Married Participant. The form of payment for a Participant who is married on his or her Benefit Commencement Date shall be a joint and 50 percent surviving spouse annuity. A joint and 50 percent surviving spouse annuity provides-(1) (2) a monthly benefit to the Participant for life; and upon the Participant's death, a monthly benefit to the Participant's surviving spouse for life equal to 50 percent of the amount payable during the Participant's lifetime.
(b)
10
(c)
Optional Payment Forms. The Plan Administrator may, in the Plan Administrators sole and absolute discretion, direct that payment be made in a form other than that described in Subsection (a) or (b). In that event, the benefit payable under the optional payment form shall be the Actuarial Equivalent of the single life annuity described in subsection (a). Payments in the Event of Plan Termination, Plan Change or Change of Control.
4.5
In the event of Plan Termination, Plan Change or Change of Control, Plan benefits will be paid to the Participants in accordance with this Subsection 4.5. In the event of a Change of Control, it is intended that any payment made under this Subsection 4.5 shall not constitute a "parachute payment" within the meaning of Section 280G (b) (2) (A) of the Code and that the Plan shall be construed to effectuate such intent. The aggregate payments to be made under the Plan to "disqualified individuals" as defined in Section 280G(c) of the Code, shall be reduced by an amount so that the Present Value of the payments which are contingent upon a Change of Control do not equal or exceed three times the Participant's average annual taxable compensation from the Company for the most recent five taxable years ending before the Change of Control. In certain circumstances payments made as a result of a Plan Termination or Plan Change that are made within one year of a Change of Control may be deemed, for income tax purposes, to be payments which are contingent on a Change of Control for purposes of Section 280G of the Code. Notwithstanding any subsequent provisions in this section 4.5 to the contrary, where any payments are to be made on account of a Plan Termination or Plan Change, all computations of such payments under this subsection 4.5 shall be made as if there were a Change of Control. In the event that a Change of Control does not occur within such one year period, such payments will be recomputed under the Plan Termination or Plan Change provisions of this subsection 4.5 and any amounts which are in excess of such payments as a result of such recomputation, plus interest at the most recent Pension Benefit Guaranty Corporation interest rate in effect for the Company's qualified pension plan, shall be paid to the Participant or the Participant's beneficiary, as applicable, within ten business days after the end of such one year period. (a) Payments to Terminated or Retired Participants. (1) Eligibility. A terminated or retired Participant, or if he is deceased, the terminated or retired Participant's beneficiary, who is receiving benefits pursuant to subsection 4.1, 4.2 or 4.3 as of the date of a Plan Termination, Plan Change or Change of Control, as applicable. Amount. A terminated or retired Participant, or if he is deceased, the retired Participant's beneficiary, who is eligible pursuant to (1) above, shall be paid the Lump Sum Actuarial Equivalent of the remaining payments to be made under the Plan to the terminated or retired Participant, or if he is deceased, the terminated or retired Participant's beneficiary. Commencement and Duration. The Lump Sum Actuarial Equivalent payable pursuant to (2) above shall be paid within ten 11
(2)
(3)
business days of the Plan Termination, Plan Change or Change of Control, as applicable. (b) Payments upon Plan Termination or Plan Change to Participants Who Have Attained Their Normal Retirement Age. (1) Eligibility. A Participant who has ten Years of Service and who has attained his Normal Retirement Age as of the date of a Plan Termination or Plan Change. Amount. A Participant who is eligible pursuant to (1) above shall be paid the Lump Sum Actuarial Equivalent of his normal retirement benefit payable pursuant to Subsection 4.1 (b) assuming that he retired on the date of the Plan Termination or Plan Change. Commencement and Duration. The Lump Sum Actuarial Equivalent payable pursuant to (2) above shall be paid within ten business days of the Plan Termination or Plan Change.
(2)
(3)
(c)
Payments upon Plan Termination or Plan Change to Participants Who Have Attained Their Early Retirement Age (1) Eligibility. A Participant who has ten Years of Service and who has attained his Earliest Retirement Age, but not his Normal Retirement Age, as of the date of a Plan Termination or Plan Change. Amount. A Participant who is eligible pursuant to (1) above shall be paid the Lump Sum Actuarial Equivalent of his early retirement benefit payable pursuant to subsection 4.1(b)(2) assuming that he retired on the date of the Plan Termination or Plan Change. Commencement and Duration. The Lump Sum Actuarial Equivalent payable pursuant to (2) above shall be paid within ten business days of the Plan Termination or Plan Change.
(2)
(3)
(d)
Payments upon Plan Termination or Plan Change to Participants Who Have Not Attained Their Early Retirement Age. (1) Eligibility. A Participant who has ten Years of Service and who has not attained his Early Retirement Age as of the date of a Plan Termination or Plan Change.
12
(2)
Amount. A Participant who is eligible pursuant to (1) above shall be paid the Lump Sum Actuarial Equivalent of his early retirement benefit payable pursuant to subsection 4.1(b)(2) assuming that he retired at his Earliest Retirement Age on the date of the Plan Termination or Plan Change and is credited with his actual number of Years of Service, actuarially adjusted to reflect his actual age on the date of the Plan Termination or Plan Change. Commencement and Duration. The Lump Sum Actuarial Equivalent payable pursuant to (2) above shall be paid within ten business days of the Plan Termination or Plan Change.
(3)
(e)
Payments upon a Participant's Termination for a Reason other than Cause Following a Change of Control. (1) Eligibility. A Participant who has ten Years of Service whose employment is terminated for any reason other than for Cause, early retirement, normal retirement, death or long-term disability after a Change of Control. Amount. A Participant who is eligible pursuant to (1) above shall be paid the Lump Sum Actuarial Equivalent of his early retirement benefit payable pursuant to subsection 4.3(b) based upon his service at termination and assuming that he retired at his Earliest Retirement Age on the Participant's date of termination. Commencement and Duration. The Lump Sum Actuarial Equivalent payable pursuant to (2) above shall be paid within ten business days of the Participant's date of termination.
(2)
(3)
(f)
Normal Retirement Benefit After a Change of Control. (1) Eligibility. A Participant who meets the eligibility requirements set forth in Subsection 4.1(a) after a Change of Control has occurred. Amount. A Participant who is eligible pursuant to (1) above shall be paid the Lump Sum Actuarial Equivalent of his normal retirement benefit payable pursuant to subsection 4.1(b). Commencement and Duration. The Lump Sum Actuarial Equivalent payable pursuant to (2) above shall be paid within ten business days of the date the Participant's employment with the Company terminates.
(2)
(3)
(g)
Early Retirement Benefit after a Change of Control. (1) Eligibility. A Participant who meets the eligibility requirements set forth in subsection 4.1(b)(2) after a Change of Control has occurred.
(2)
Amount. A Participant who is eligible pursuant to (1) above shall be paid 13
the Lump Sum Actuarial Equivalent of his early retirement benefit payable pursuant to subsection 4.1(b)(2). (3) Commencement and Duration. The Lump Sum Actuarial Equivalent payable pursuant to (2) above shall be paid within ten business days of the date the Participant's employment with the Company terminates.
(h)
Disability Retirement Benefit After a Change of Control. (1) Eligibility. A Participant who is or has been determined to be totally disabled (either before or after a Change of Control) as defined by the Company's Long-Term Disability Plan on or after he has completed ten Years of Service, after a Change of Control has occurred. Amount. A Participant who is eligible pursuant to (1) above shall be paid the Lump Sum Actuarial Equivalent of his disability retirement benefit payable pursuant to subsection 4.2(b), assuming Service through his Normal Retirement Age. The Lump Sum Actuarial Equivalent shall be actuarially adjusted to reflect his actual age on the date of payment. Commencement and Duration. The Lump Sum Actuarial Equivalent payable pursuant to (2) above shall be paid within ten business days of the later of the date the Participant is determined to be totally disabled or the date of Change of Control.
(2)
(3)
(i)
Death Benefit after a Change of Control. (1) Eligibility. A beneficiary of a Participant who meets the eligibility requirements set forth in subsection 5.1(a) or (b), after a Change of Control has occurred. Amount. A beneficiary who is eligible pursuant to (1) above shall be paid the Lump Sum Actuarial Equivalent of his monthly benefit payable pursuant to subsection 5.2 (a) or (b). Commencement and Duration. The Lump Sum Actuarial Equivalent payable pursuant to (2) above shall be paid within ten business days of the Participant's death.
(2)
(3)
4.6
No Payments upon a Participant's Termination for Cause
Notwithstanding another provision of the Plan, if a Participant is terminated for Cause, no benefit will be due or payable under the Plan.
14
Section V. 5.1 (a) Eligibility.
Preretirement Death Benefits
Active Employees. In the case of a Participant who has a vested interest in his accrued benefit under the Pension Plan, and who dies while actively employed by the Company or an Affiliate, there shall be payable to his or her Beneficiary a lump sum preretirement death benefit equal to the amount determined under subsection 5.2 (a). Former Employees. In the case of a former Participant who has a vested interest in his accrued benefit under the Pension Plan, and who dies after his Termination of Service but before his Benefit Commencement Date, there shall be payable to such Participants' surviving spouse a preretirement survivor annuity equal to the amount determined under subsection 5.2 (b). No other Death Benefits. If a Participant dies before earning a vested interest in his or her accrued benefit under the Pension Plan, or if a former Participant does not have a surviving spouse, no death benefits shall be payable on the Participants' behalf. Amount. Active Employees. The benefit payable to an eligible Beneficiary under subsection 5.1 (a) shall be a lump sum benefit payment that is the Actuarial Equivalent of the monthly benefit accrued by the Participant under section 4.1 as of the date of his death, reduced in the same manner and amount as preretirement death benefits under the Pension Plan if the date of the Participant's death precedes his Normal Retirement Date. Former Employees. The monthly payments to an eligible surviving spouse under subsection 5.1(b) shall equal the amount that would have been payable as a survivor annuity under the form of payment described in subsection 4.4(b) if -(1) in the case of a Participant who dies after attaining his Earliest Retirement Age, the Participant had retired with an immediate benefit under subsection 4.4 (b) on the day before his death. in the case of a Participant who dies on or before attaining his Earliest Retirement Age, the Participant had terminated employment on the date of death (if employment had not yet terminated), survived to the Earliest Retirement Age, retired with an immediate benefit under subsection 4.4(b) at the Earliest Retirement Age, and died on the day after the day on which he would have attained the Earliest Retirement Age.
(b)
(c)
5.2 (a)
(b)
(2)
5.3 Commencement. Payment of the preretirement death benefit under this Section V shall commence on the first day of the month coinciding with or next following the date of the Participant's death.
15
Section VI.
Financing
6.1 Financing. The benefits under the Plan shall be paid out of the general assets of the Employer. The benefits shall not be funded in advance of payment in any way. 6.2 No Trust Created. Nothing contained in the Plan, and no action taken pursuant to the provisions of the Plan, shall create a trust of any kind or a fiduciary relationship between an Employer and any Participant, Participant's spouse, beneficiary, or any other person. Notwithstanding the foregoing, a Rabbi Trust can be established by the Plan Administrator if deemed to be beneficial to the Plan Participants. 6.3 Unsecured Interest. No Participant shall have any interest whatsoever in any specific asset of the Company or an Affiliate. To the extent that any person acquires a right to receive payments under the Plan, such right shall be no greater than the right of any unsecured general creditor of an Employer.
16
Section VII.
Administration
7.1 Administration. The Plan shall be administered by the Plan Administrator. The Plan Administrator shall have all the powers necessary or appropriate to carry out the provisions of the Plan. The Plan Administrator may, from time to time, establish rules for the administration of the Plan and the transaction of the Plan's business. The Plan Administrator shall have the exclusive right to make any finding of fact necessary or appropriate for any purpose under the Plan including, but not limited to, the determination of eligibility for and amount of any benefit. The Plan Administrator shall have the exclusive right to interpret the terms and provisions of the Plan and to determine any and all questions arising under the Plan or in connection with its administration, including without limitation, the right to remedy or resolve possible ambiguities, inconsistencies or omissions by general rule or particular decision, all in the Plan Administrator's sole and absolute discretion. To the extent permitted by law, all findings of fact, determinations, interpretations and decisions of the Plan Administrator shall be conclusive and binding upon all persons having or claiming to have any, interest or right under the Plan. 7.2 Appeals from Denial of Claims. If any claim for benefits under the Plan is wholly or partially denied, the claimant shall be given notice of the denial. The notice shall be in writing within a reasonable period of time after receipt of the claim by the Plan Administrator's, not to exceed 90 days after receipt of the claim; provided, however, if special circumstances require an extension of time, written notice of such extension, not to exceed an additional 90 days, shall be furnished to the claimant. Such notice shall be written in a manner calculated to be understood by the claimant and shall set forth the following information: (a) (b) (c) the specific reasons for the denial; specific reference to the Plan provisions on which the denial is based. a description of any additional material or information necessary to be submitted by the claimant to perfect the claim and an explanation of why this material or information is necessary; an explanation that a full and fair review by the Plan Administrator of the decision denying the claim may be requested by the claimant or an authorized representative by filing with the Plan Administrator, within 60 days after the notice has been received, a written request for the review; if this request is so filed, an explanation that the claimant or an authorized representative may review pertinent documents and submit issues and comments in writing within the same 60-day period specified in Subsection (d).
(d)
(e)
17
The decision of the Plan Administrator upon review shall be made promptly, but not later than 60 days after the Plan Administrator's receipt of the request for review, unless special circumstances require an extension of time for processing, in which case the claimant shall be so notified, and a decision shall be rendered as soon as practicable, but not later than 120 days after receipt of the request for review. If the claim is denied, in whole or in part, that claimant shall be given a copy of the decision promptly. The decision shall be in writing, shall include specific reasons for the denial, shall include specific references to the pertinent Plan provisions on which the denial is based, and shall be written in a manner calculated to be understood by the claimant. 7.3 Tax Withholding. The Employer may withhold from any payment under this Plan any federal, state, or local taxes required by law to be withheld with respect to the payment and any sum the Employer may reasonably estimate as necessary to cover any taxes for which they may be liable and that may be assessed with regard to such payment. Upon discharge or settlement of such tax liability, the Employer shall distribute the balance of such sum, if any, to the Participant from whose payment it was withheld, or if such Participant is then deceased, to the beneficiary of such Participant. Prior to making any payment hereunder, the Company may require such documents from any taxing authority, or may require such indemnities or surety bond as the Company shall reasonably deem necessary for its protection. As to any payroll tax that must be withheld in accordance with the applicable statute, the Employer may withhold as necessary any payroll taxes that are due. 7.4 Expenses. All expenses incurred in the administration of the Plan shall be paid by the Employer. 7.5 Actuarial Equivalence. In determining the actuarial equivalent value of a benefit payable under the Plan or of any other benefit, the Company, in consultation with an actuary selected by the Company, shall use any generally accepted actuarial tables and reasonable interest assumptions, as the Company shall determine in its sole and absolute discretion. 7.6 Liability of Plan Administrators; Indemnification. To the extent permitted by law, the Plan Administrators shall not be liable to any person for any action taken or omitted in connection with the interpretation and administration of the Plan unless attributable to his own gross negligence or willful misconduct. The Company shall indemnify the Plan Administrators against any and all claims, losses, damages, expenses, including counsel fees, incurred by them, and any liability, including any amounts paid in settlement with their approval, arising from their action or failure to act, except when the same is judicially determined to be attributable to their gross negligence or willful misconduct.
18
Section VIII. Adoption of the Plan by the Affiliate; Amendment and Termination of the Plan. 8.1 Adoption of the Plan by the Affiliate. An Affiliate may adopt the Plan by appropriate action of its board of directors or authorized officers or representatives, subject to the approval of the Board. 8.2 Amendment and Termination of the Plan. The Company hereby reserves the right to amend, modify or terminate the Plan at any time, and for any reason, by action of the Board. However, no amendment or termination shall have the effect of reducing the benefits accrued by a Participant prior to the date of the amendment or termination. Notice of any such amendment or termination shall be given in writing to each Participant and beneficiary of a deceased Participant having an interest in the Plan.
19
Section IX.
Miscellaneous Provision
9.1 No Contract of Employment. Nothing contained in the Plan shall be construed to give any Participant the right to be retained in the service of the Company or its Affiliates or to interfere with the right of the Company or its Affiliates to discharge a Participant at any time. 9.2 Severability. If any provision of this Plan shall be held illegal or invalid, the illegality or invalidity shall not affect its remaining parts. The Plan shall be construed and enforced as if it did not contain the illegal or invalid provision. 9.3 Applicable Law. Except to the extent preempted by applicable federal law, this Plan shall be governed by and construed in accordance with the laws of the state of North Carolina.
IN WITNESS WHEREOF, FIRST UNION CORPORATION has caused this instrument to be executed by its duly authorized officer, effective as of the date specified above.
FIRST UNION CORPORATION By: Title:
20
Schedule A
First Fidelity Benefit Equalization Plan
21
Exhibit (12)(a) WACHOVIA CORPORATION AND SUBSIDIARIES COMPUTATIONS OF CONSOLIDATED RATIOS OF EARNINGS TO FIXED CHARGES Years Ended December 31, (In millions) EXCLUDING INTEREST ON DEPOSITS Pretax income from continuing operations Fixed charges, excluding capitalized interest Earnings Interest, excluding interest on deposits One-third of rents Capitalized interest Fixed charges (a) Consolidated ratios of earnings to fixed charges, excluding interest on deposits INCLUDING INTEREST ON DEPOSITS Pretax income from continuing operations Fixed charges, excluding capitalized interest Earnings Interest, including interest on deposits One-third of rents Capitalized interest Fixed charges (a) Consolidated ratios of earnings to fixed charges, including interest on deposits 2006 2005 2004 2003 2002
$
11,470 8,189 19,659 7,897 292 8,189
9,462 4,971 14,433 4,711 260 4,971
7,633 2,701 10,334 2,474 227 2,701
6,080 2,309 8,389 2,113 196 2,309
4,667 2,414 7,081 2,247 167 2,414
(A) $ $
(B) $
(A)/(B)
2.40 X
2.90
3.83
3.63
2.93
$
11,470 17,308 28,778 17,016 292 17,308
9,462 10,268 19,730 10,008 260 10,268
7,633 5,554 13,187 5,327 227 5,554
6,080 4,669 10,749 4,473 196 4,669
4,667 5,844 10,511 5,677 167 5,844
(C) $ $
(D) $
(C)/(D)
1.66 X
1.92
2.37
2.30
1.80
(a) The amount of fixed charges do not include other obligations which exist under Financial Accounting Standards Board Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Others".
Exhibit (12)(b) WACHOVIA CORPORATION AND SUBSIDIARIES COMPUTATIONS OF CONSOLIDATED RATIOS OF EARNINGS TO FIXED CHARGES AND PREFERRED STOCK DIVIDENDS Years Ended December 31, (In millions) EXCLUDING INTEREST ON DEPOSITS Pretax income from continuing operations Fixed charges, excluding preferred stock dividends and capitalized interest Earnings Interest, excluding interest on deposits One-third of rents Preferred stock dividends Capitalized interest Fixed charges (a) Consolidated ratios of earnings to fixed charges, excluding interest on deposits INCLUDING INTEREST ON DEPOSITS Pretax income from continuing operations Fixed charges, excluding preferred stock dividends and capitalized interest Earnings Interest, including interest on deposits One-third of rents Preferred stock dividends Capitalized interest Fixed charges (a) Consolidated ratios of earnings to fixed charges, including interest on deposits 2006 2005 2004 2003 2002
$
11,470
9,462
7,633
6,080
4,667
(A) $ $
8,189 19,659 7,897 292 8,189
4,971 14,433 4,711 260 4,971
2,701 10,334 2,474 227 2,701
2,309 8,389 2,113 196 5 2,314
2,414 7,081 2,247 167 19 2,433
(B) $
(A)/(B)
2.40 X
2.90
3.83
3.63
2.91
$
11,470
9,462
7,633
6,080
4,667
(C) $ $
17,308 28,778 17,016 292 17,308
10,268 19,730 10,008 260 10,268
5,554 13,187 5,327 227 5,554
4,669 10,749 4,473 196 5 4,674
5,844 10,511 5,677 167 19 5,863
(D) $
(C)/(D)
1.66 X
1.92
2.37
2.30
1.79
(a) The amount of fixed charges do not include other obligations which exist under Financial Accounting Standards Board Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Others".
Expanding the Possibilities
2006 Annual Report
Wachovia Overview
Strength in Attractive Growth Markets
Determination to succeed and devotion to customer service are part of Wachovia’s heritage
Business Description
Wachovia Corporation (NYSE:WB) is one of the nation’s largest diversified financial services companies, serving 13 million customers with a broad range of retail banking and brokerage, asset and wealth management, and corporate and investment banking products and services. We operate the nation’s fourth largest banking company, serving retail and commercial banking customers through 3,400 retail banking offices in 21 states from Connecticut to Florida and west to Texas and California. In addition, we are pleased to serve customers’ brokerage and asset management needs through the nation’s third largest retail brokerage firm, with 750 Wachovia Securities, LLC, offices in 47 states and through service affiliate offices in Latin America. We also serve corporate and investment banking clients in selected corporate and institutional sectors globally. Our other nationwide businesses include mortgage lending in all 50 states and auto finance covering 46 states. Globally, Wachovia provides international correspondent banking services and trade finance through more than 40 international offices. Online banking is available at wachovia.com, online brokerage products and services at wachoviasec.com, and investment products and services at evergreeninvestments.com. At December 31, 2006: Assets: $707 billion Market capitalization: $108 billion Stockholders’ equity: $69.7 billion
Retail Bank and Brokerage footprint Additional Retail Brokerage footprint More information on page 131.
4,100 financial centers and brokerage offices across the U.S.
Common shares outstanding: 1.9 billion Listing: NYSE Ticker symbol: WB
Contents
Letter to Our Shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Corporate Citizenship . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Corporate Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Overview of Major Businesses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Guide to Our Financial Discussion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Management’s Discussion and Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Management’s Report on Internal Control over Financial Reporting . . . . . . . . . . . . . . . . . . . . . 62 Reports of Independent Registered Public Accounting Firm . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 Glossary of Financial Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130 Board of Directors and Operating Committee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 132 Shareholder Information (Dividend and Stock Price tables on pages 1, 31, 45, 46, 47 and 49) . . . . . . Inside Back Cover
Financial Highlights
The Year at a Glance
■ ■ ■ ■
5th consecutive year of double-digit earnings growth
Revenue
133% increase in dividends since year-end 2001 No. 1 in customer service among banking peers for six years Entered attractive new markets with Golden West and Westcorp
(In billions)
7% G rowt h*
$29.9 $26.1 $23.0
04
05
06
Common stock dividends up 60% since 4Q03
Including predecessor Union National Bank, dividends paid every year since 1910 Dividends Per Share and Payout Ratio
45.1%
50.5% 44.0% 41.8%
Net Income
45.5% 45.2% $0.56 $0.56
(In billions)
22% Grow
600 500 400 300 200 100 0
37.2% 38.8% 38.8%
38.1%
44.2% 42.6% 41.4%
th*
$7.8 $6.6
$0.51 $0.51 $0.51 $0.51 $0.46 $0.46 $0.46 $0.40 $0.40 $0.40 $0.35 $5.2
4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06
04
05
06
Dividend payout ratio: Dividends per common share divided by earnings per common share (excludes net merger-related and restructuring expenses, other intangible amortization, discontinued operations and change in accounting principle).
Earnings up 22% on a compound annual basis since 2004
Financial Performance Highlights
Years Ended December 31, (Dollars in millions, except per share data)
Diluted EPS
(Dollars per share)
* owth
Total revenue (Tax-equivalent) Income from continuing operations Net income Diluted earnings per common share Income from continuing operations Net income Return on average tangible common stockholders’ equity Total assets Stockholders’ equity Actual common shares (In millions) Dividends paid per common share Book value per common share Common stock price Market capitalization Financial centers/brokerage offices Employees
$
2006 29,949 7,745 7,791 4.61 4.63 30.16 % 707,121 69,716 1,904 2.14 36.61 56.95 108,443 4,126 108,238
2005 26,119 6,429 6,643 4.05 4.19 27.85 520,755 47,561 1,557 1.94 30.55 52.86 82,291 3,850 93,980
2004 22,990 5,214 5,214 3.81 3.81 24.61 493,324 47,317 1,588 1.66 29.79 52.60 83,537 3,971 96,030
r 5% G
$4.63 $4.19 $3.81
$ $ $ $
04
05
06
$
*Compound annual growth rate. Includes acquisitions.
For an explanation of our use of non-GAAP financial measures, please see Table 1 on page 45.
Wachovia Corporation 2006 Annual Report
1
Letter to Our Shareholders
Dear Shareholders, I am proud of the performance of our entire team in 2006 in delivering double-digit earnings growth while at the same time strengthening Wachovia’s future prospects. Wachovia’s earnings rose 17 percent from 2005 to $7.8 billion, and earnings per share rose 11 percent to $4.63. These results include the addition of Golden West Financial on October 1, 2006, and Westcorp on March 1, 2006.
5-Year Total Return exceeds industry benchmarks
We achieved these results despite the impact of the inverted yield curve, which squeezed industry profit margins and caused our net interest income growth to be lower than we’d expected. But we benefitted from robust fee income and stellar credit quality, and delivered the bottom line we’d expected when we presented our 2006 outlook to investors in January a year ago. I am disappointed, however, that our shareholders were not rewarded in 2006 with a higher share price commensurate with the quality and strength of our financial results. Our stock price underperformance was primarily due to the market’s reluctance to embrace our acquisition of Golden West. We believe this reluctance largely stemmed from short-term concerns over the perceived difficulty of combining our business models and fears of a weakening mortgage market. While these will be challenges in 2007, we considered them thoroughly when we evaluated this acquisition. We concluded that the extraordinary opportunity to leverage Golden West’s lending model across our entire marketplace and to gain important retail locations in fast-growing western states provided significant opportunities that outweighed any short-term concerns surrounding the weak mortgage market.
Expanding the Possibilities
With our expansion into California, Arizona, Nevada, Colorado, Texas and other states, we’re leapfrogging ahead in our plans to build new branch offices, and we’re establishing a beachhead to build our commercial, small business and wealth clientele. We have long said we do not need to be in all 50 states; instead, we have been strategically focused on expanding into fast-growing markets, and our western expansion clearly supports this strategy. California alone represents 13 percent of the nation’s gross domestic product and the Far West is one of the fastest-growing regions in the nation.
Total Return 2001-2006
120% 100% 80% 60% 40% 20% S&P 500 35% 0% -20% -40% 4Q01 4Q02 4Q03 4Q04 4Q05 4Q06 Bank Index 60% WB 115%
In addition, Wachovia has other significant strengths that I believe will also help afford us a superior share price over time: We have a mix of businesses with scale and relevance to our customers; We have both traditional and market-related businesses that provide earnings growth during differing economic conditions without requiring us to take unacceptable risks; and We have a proven management team recognized by investors, analysts, and competitors for its ability to execute. These strengths have driven our performance over the past five years, even while we integrated First Union and Wachovia, SouthTrust, Prudential's retail brokerage business, Westcorp, and a number of smaller acquisitions. As a result, over the five-year period between the end of 2001 and the end of 2006, Wachovia was the best performing stock among the 20 largest banking companies in the United States, with an average annual return nearly 7 percent higher than that achieved by the broad KBW Bank index. 2006 further reinforced my confidence that our mix of businesses provides the best route to strong performance across a broad range of economic environments. We saw record results in our capital markets-oriented businesses in a year in which the industry was challenged by an inverted yield curve, a slowing mortgage market, a dramatic slowdown in deposit growth and the migration of deposit balances to higher cost products. For many banks, these trends translated into weak earnings growth in 2006 and even weaker prospects for 2007. Wachovia’s 2006 earnings were within 1 percent
Beginning December 31, 2001. More information is on page 46.
2
Wachovia Corporation 2006 Annual Report
“We take great pride in delivering on what we promise.”
Ken Thompson
Chairman and Chief Executive Officer
Wachovia Corporation 2006 Annual Report
3
Letter to Our Shareholders
of our expectations in the fall of 2005, at which time the challenges facing banks were much less severe. Our success was enhanced by the strong performance of the markets-related businesses in our Corporate and Investment Bank and in our Capital Management Group, but it was founded on the performance of our General Banking Group.
Balanced, Diversified Businesses
We’ve outperformed our peers over the long term
The General Bank, which is led by Ben Jenkins, generated 65 percent of our segment earnings in 2006. Delivering double-digit net income growth in the challenging environment of 2006 is testimony to the quality of this team. In addition to driving day-to-day performance, the General Bank added Westcorp’s attractive auto lending platform, launched Wachovia’s reentry into the credit card business, opened 85 de novo financial centers, built and began implementing the Golden West integration strategy, and executed numerous strategies to improve its efficiency. All of these initiatives enhance the prospects of our General Banking business. We are committed to continued investment in our banking franchise. New business lines, new geographies and new financial centers are evidence of this commitment. What is not so easy to see is the significant investment in our core execution strategies. Wachovia’s success in leading the industry in customer service for the last six years has attracted attention, and competitors are trying very hard to replicate our success. Eventually, some will be successful and that competitive advantage will be diminished. So in response we remain obsessive about our attention to service, but we also are focused now on improving customer loyalty. Service has permitted Wachovia to enjoy industry-leading customer retention. Now we look to build upon our competitive advantage in acquiring new customers and in developing a complete set of relationships with those customers. While we earn high marks for the quality and breadth of our product offerings, we are challenging ourselves to be better at seamless coordination between delivery channels, alignment of incentive plans, and ensuring that competing priorities do not hurt our results. We have great untapped potential to improve profitability by fixing these issues and we are all about executing on these priorities. Today, 52 percent of our customers are measured as loyal compared with under 40 percent when we began measuring customer loyalty in 2002. Our second traditional banking business is Wealth Management, headed by Stan Kelly. Wealth Management posted earnings growth of 8 percent in 2006. That was short of goal, but when I assess the business environment and the progress Stan’s team made in repositioning the business for future growth, I am pleased with the performance. This business, which is focused on meeting the financial needs of high net worth clients and serving the insurance needs of commercial customers, was challenged by all the factors affecting traditional banking and, in addition, by a “soft” or weak market for insurance brokerage commissions. As we looked to the future, it was clear that to be relevant to our affluent clients we needed to dramatically enhance our investment advisory offering and to take cost out of our delivery model. So in 2006, Wealth Management implemented a new “open architecture” investment platform called Advantage, while at the same time it reduced management layers to provide more direct lines of accountability. Because of the quality of Advantage, our Wealth Management Group was named Platform Provider of the Year by Private Asset Management, a publication of Institutional Investor. About one-third of our clients were presented with the Advantage model in 2006 and the vast majority elected to move their assets to the new model. This gives me confidence that Wealth Management is positioned for strong earnings growth in 2007 and beyond. The Corporate and Investment Bank, led by Steve Cummings, generated 25 percent of our segment earnings in 2006 and organically grew overall market share in virtually every domestic investment banking category. Nearly 30 percent of the group’s 2006 revenue came from annuity-like businesses aligned with Wachovia’s commercial banking strengths such as cash management, trade finance and asset-based lending, with the remaining 70 percent of revenues driven by capital markets activity. Our capital markets business is heavily weighted to fixed income and focuses on high margin, non-commodity businesses.
Strong Growth in EPS vs. Peers*
vs. 1 Year Ago
50
vs. 2001 (CAGR)
100
17.1%
40 80
30
60
8.8% 7.9%
20 40
10.4%
10
20
0
0
Median Top 20 U.S. Banks
Wachovia
*Represents net income excluding merger-related and restructuring expenses, discontinued operations and other noncash charges.
5-Year Total Return Outperformance
KBW Bank Index -11% 34% 10% 3% 17% 60% S&P 500 -22% 29% 11% 5% 16% 35%
WB 2002 2003 2004 2005 2006 Year-end 2001-2006 20% 32% 17% 4% 12% 115%
4
Wachovia Corporation 2006 Annual Report
Our business is client-driven and we are intensely focused on clients where we can add value by providing both intellectual and balance sheet capital. This approach has allowed Steve and his team to double our domestic market share and grow faster than our major investment banking competitors over the past five years while actually reducing the capital needed to support the business. The financial landscape is rapidly changing with growing capital markets opportunities in Europe, the acceleration of Asian economies and the increasing importance of the financial sponsors business both in the U.S. and internationally. Transactions are trending larger and are more complex. To some extent, this risk is being offset by the emergence of new institutional investors and generally greater financial transparency and enhanced corporate governance. But to be relevant to our clients and institutional investors we will need to continue to deliver innovative new solutions and serve new markets. Our approach will be to focus our people and our investments only in those businesses where we have a clear competitive advantage. Structured products and real estate capital markets are demonstrated areas of leadership for Wachovia where client focus can extend our reach into profitable markets while enhancing the risk return profile of our businesses. Our second markets-related business is our Capital Management Group, led by David Carroll. This business includes Wachovia Securities, LLC, which is the nation’s third largest retail brokerage firm, and a growing asset management business that includes Evergreen Investments and our retirement business. These businesses had a very successful year, with revenue up 12 percent and earnings up 34 percent.
Strategic Priorities
■ ■ ■ ■ ■ ■
Employee Engagement Customer Loyalty Revenue Growth Expense Control Merger Integration Corporate Governance
No. 1 for 6th Consecutive Year
The Capital Management team has identified its businesses’ core competencies, implemented efficiency improvements and successfully integrated several acquisitions. As a result, they’ve improved their overhead efficiency from above 85 percent two years ago to 75.65 percent in 2006. Particularly encouraging is the progress this team has made in growing bottom line profits while transitioning to a business with more recurring, annuity-like revenue streams. In 2006, recurring revenues represented 61 percent of total revenue in our brokerage business, up from 50 percent in 2004. Over the past two years, David and his team also have been very focused on improving performance in our asset management business. We have made strategic acquisitions where we needed to enhance our core competencies in asset classes that are relevant to our clients, including Metropolitan West Capital Management and Golden Capital Management, two top decile performers in large cap value and large cap core investment styles. As 2007 begins, this team is intently focused on developing its majority interest partnership with European Credit Management, a London-based fixed income investment management firm, which adds additional asset management expertise and strengthens Evergreen’s global distribution platform. We also have made progress in capitalizing on synergies between our large retail brokerage business and other business segments, yet this remains one of the most substantive opportunities for Wachovia. Providing investment product to General Bank and Wealth customers, offering loans and deposits to brokerage customers, and distributing product originated by our Investment Bank to brokerage customers are all examples of early successes that can produce outstanding results in 2007 and beyond if we execute properly.
2006 American Customer Satisfaction Index (ACSI) Score 2006 vs. 2001 Wachovia Bank of America JP Morgan Chase/ Bank One Wells Fargo Retail Banks Industry Average 80 72 72 72 77 + 11 % + 6% + 9% + 9% + 7%
Source: ACSI independent survey fourth quarter 2006.
Percentage Loyal Customers*
600
500
49% 45%
51%
52%
55%
400
300
Valuing Team Contributions
I’ve often said that the passion, creativity and performance discipline of our people are what defines our long-term competitive advantage. There’s a palpable sense of pride in being with Wachovia. We firmly believe our success in building customer loyalty is no accident, but a direct link to our emphasis on ensuring that our employees are fully engaged and know how their work contributes to our success. Valuing employees and satisfying customers lead the list of the six strategic priorities that have guided our company for the past three years. Our strategic priorities build upon each other: Because of our employees’ dedication, Wachovia has become the acknowledged industry leader in providing superior customer service. As a result, customer attrition
200
100
0
4Q03 4Q04 4Q05 4Q06 Goal
*Defined as a customer who rates Wachovia a "7" on three loyalty questions.
Wachovia Corporation 2006 Annual Report
5
Letter to Our Shareholders
has dramatically declined, which enhances revenue growth and expense control. As you read this report, we have completed the Westcorp merger integration and we are well into our Golden West integration effort. Through good partnership and sound execution, the integration is “on plan.”
Corporate Governance
Revenue growth and expense efficiency are equal priorities
By listing corporate governance among the six strategic priorities that guide us, we’re emphasizing our pledge to shareholders to remain committed to delivering best-in-class corporate governance. A key element of corporate governance is transparency in financial disclosure. Because we value financial transparency, we have previously been disclosing much of the additional information around executive compensation and benefits that the Securities and Exchange Commission is now requiring in 2007. We believe our executive compensation and benefit policies will compare favorably because we have a long record of making sure that our executives’ interests are aligned closely with shareholder interests. For example: As CEO, I do not have an employment contract or a severance agreement or golden parachute. We elected a lead independent director in 2000. We long ago strengthened stock ownership guidelines for management and directors. We adopted a policy requiring shareholder approval of any future senior executive severance agreements providing benefits over 2.99 times the executive’s annual base salary plus bonus as described in the policy.
Revenue Outpaces Expense Growth*
(In billions)
100 600
Goals for 2007
For the next year, we will maintain our focus on execution as we migrate the Golden West mortgage model to Wachovia channels and as we introduce Wachovia’s General Banking model to our new western markets. At the same time, we will continue to grow our core businesses by capitalizing on the opportunities I have discussed in this letter. I believe that the wealth of opportunities available to us are a great indication of the strength and potential of this company.
$29.9 $26.1
500 80
$23.0
400 60
Total revenue up 7% CAGR
300
40 200
$13.8 $15.1 $16.9
20 100
Noninterest expense up 5% CAGR
Pride With Wachovia
Determination is one of the defining strengths of our company. We take great pride in delivering on what we promise. In 2007 we are more determined than ever to ensure our investors share in our success, and we will not rest until the markets respond with a valuation that reflects our financial performance. We fully expect to deliver on our goal of being a top quartile performer for our investors. 2006 was an important year for Wachovia for many reasons. One of the most important was that it brought Herb and Marion Sandler into our corporate family. Herb and Marion built a company, Golden West, which had perhaps the greatest record of any American corporation over the last 25 years. For the last few months Wachovia has been the beneficiary of their management skills and wisdom. Both will be available to us over the next two years in a consulting capacity and I look forward to their frequent counsel. I want to thank our employees for their consistently superb quality of work and their dedication. It is thrilling to work with these teammates every day. I also want to offer my appreciation to our board, whose work ethic, diligence and strategic advice are invaluable. And, especially, I’d like to thank our customers for their continued business with Wachovia.
0
04
05
06
*Excluding merger-related and restructuring charges and intangible amortization.
Improved Overhead Efficiency*
800
63.6%
700
59.1% 60.6% 60.0% 58.0% 56.3% 51.553.5%
600
500
400
300
200
Sincerely,
01 02 03 04 05 06 07 Goal
100
0
*Overhead efficiency ratio excludes merger-related and restructuring expenses, changes in accounting principle and other intangible amortization.
G. Kennedy Thompson Chairman, President and Chief Executive Officer February 23, 2007
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Wachovia Corporation 2006 Annual Report
Wachovia’s Community Commitment
Wachovia is committed to building strong, vibrant communities, improving the quality of life and making a positive difference where we live and work. Every year, Wachovia invests billions of dollars to improve neighborhoods and education in the markets we serve.
But giving back to the community means more than just making financial contributions. We also encourage our employees to provide leadership through civic efforts and volunteering. We support their efforts through our Time Away From Work for Community Service policy, which allows employees to take four paid hours per month to volunteer. We also forge partnerships with local and regional nonprofit organizations to deliver services and programs, and help hundreds of lower-income families achieve the dream of home ownership every week.
Community Loans and Investments*
(In billions)
120
Charitable Giving*
(In millions)
100 600
$30 $26
$145
500 80
00
$104
$128
$25
80
400 60
$82
$105 $118
Direct and In-Kind
60
300
40 40 200
20
20 100
$22
$23
$27
Employee Giving
0
04
05
06
0
04
05
06
*Affordable housing, Small Business/ farm, consumer credit and community development loans.
*Primarily support for education, community development, health and human services, and arts and culture.
One of the nation’s leading community development lenders
Helped nearly 15,000 low- to moderate-income families buy homes each week Invested nearly $210 million in equity to create over 1,700 affordable rental housing units Received a $143 million fourth round allocation of New Markets Tax Credits, making Wachovia the third largest recipient and single largest bank recipient under this program. In 2006, created nearly 1,850 jobs in lower-income communities through $74 million in lending through New Markets Tax Credits projects Trained 26,000 families and individuals in personal computer, Internet and money management skills through our financial literacy programs led by employee volunteers in conjunction with community groups; offered in English and Spanish Launched “Extra Credit,” a financial literacy lesson that addresses debt management and how to establish and maintain good credit
One of the nation’s leaders in corporate philanthropy and community involvement
Reading First, our early childhood literacy program, involved employees in nearly 6,100 partnerships with local classrooms, with 121,000 books donated to classroom libraries Logged more than 700,000 employee volunteer hours, including building homes, mentoring children, reading in schools and tutoring adults in financial literacy Over 1,960 grants amounting to $268,400 to the charity of choice for employees who volunteered at least 24 hours with that organization Donated $1 million in proceeds from Wachovia Championship PGA TOUR golf tournament to Teach For America Launched the 32nd chapter of WachoviaVolunteers!, the community involvement network for employees. One in four employees is now a member
Providing corporate leadership in environmental stewardship
In 2006, Wachovia adopted a set of Environmental Principles to guide its business. The complete set of principles are accessible through the Company Information link at Wachovia.c0m. Highlights include: Forest Protection Established policy prohibiting the financing of illegal logging and any logging operations in primary tropical moist forests, areas in which high conservation values are endangered or World Heritage sites Encouraged clients to adopt a credible forest certification program and show third-party verification of sustainable forestry practices Became a signatory to the Equator Principles, which commit financial institutions to mitigating social and environmental risk factors in global project financing Waste Reduction Recycled more than 20,000 tons of paper in 2006 Used recycled paper for 86 percent of 2006 print materials, including customer correspondence, the Annual Report, marketing collateral and direct mail Climate Change Committed to reduce Wachovia’s absolute carbon dioxide emissions by 10 percent from 2005 levels by 2010 Designed a new 1.2 million square foot office tower in accordance with Leadership in Energy and Environmental Design (LEED) certification standards Opened first LEED-certified financial center in Austin, Texas Purchased renewable energy where available; in Texas, 10 percent of electricity supplied by wind power Industry Leadership Signatory to the United Nations Environment Programme Finance Initiative (UNEPFI) Founding member of the Environmental Bankers Association Included in the FTSE4Good Global Index and the Carbon Disclosure Project
Wachovia Corporation 2006 Annual Report
7
Corporate Overview
Segment Revenue Contribution
(In millions)
1% 5%
An uncommon partnership of banking and
52%
20%
brokerage businesses to bridge a lifetime of customer needs
22%
General Bank $15,700 Corporate and Investment Bank $6,657 Capital Management $6,022 Wealth Management $1,387 Parent $183
Diversified Business Mix
Steady revenue stream in a challenging environment and upside potential in an improving economy Relatively stable mix of interest income and fee income About half of Wachovia’s 2006 revenue came from banking and wealth management operations and half from a broad array of corporate and investment banking, brokerage and asset management businesses
Broad Distribution Network
4,100 financial centers and brokerage offices, 5,200 ATMs, telephone and Internet Sales force of 43,000 bank sales and service associates; 10,600 registered representatives, including 2,500 licensed financial specialists and 8,100 full-service brokers, 1,300 of whom are in financial centers; 950 wealth management advisors; 255 insurance brokers in 40 insurance brokerage offices; 1,500 commercial, small business and private advisory relationship managers; and 1,200 corporate and institutional coverage officers
Preferred by Customers
Record customer satisfaction and loyalty rankings among industry best in class No. 1 among major U.S. banks (Consumer Reports); No. 1 among major U.S. banks and No. 5 among all U.S. banks (J.D. Power and Associates)
Growth Potential
Core relationship products drive growth – average core deposits up 11 percent and average loans up 35 percent Broad product array with expanded branch network, credit card and mortgage offerings, and auto dealer services Positioned for growth in global payments industry
8
Wachovia Corporation 2006 Annual Report
Overview of Major Businesses
General Bank
Our General Bank provides a broad range of banking products and services to individuals, small businesses, commercial enterprises and governmental institutions in 21 states and Washington, D.C. We focus on small business customers with annual revenues up to $3 million; business banking customers with annual revenues between $3 million and $15 million; and commercial customers with revenues between $15 million and $250 million. In addition, we serve mortgage customers in 50 states and provide auto finance covering 46 states.
2006 Business Fundamentals $15.7 billion total revenue $223.4 billion average loans $232.7 billion average core deposits $4.1 billion investment sales 11.5 million households and businesses 55,600 employees 2,500 licensed financial specialists 12.3 million online product and service enrollments and 4.0 million active online customers
Wealth Management
With nearly 200 years of experience in managing wealth, Wealth Management tailors the capabilities of a major financial institution to the individual needs of high net worth individuals, their families and businesses. Teams of relationship managers and specialty advisors serve clients with $2 million or more in investable assets, while four family offices focus on families with $25 million or more in investable assets. Wachovia Insurance Services provides commercial insurance brokerage and risk management services, employee benefits, life insurance, executive benefits and personal insurance services to businesses and individuals.
2006 Business Fundamentals $1.4 billion total revenue $16.2 billion average loans $14.5 billion average core deposits $72.4 billion assets under management $143.9 billion assets under administration 950 wealth management advisors 255 insurance brokers
Corporate and Investment Bank
Our Corporate and Investment Bank offers a full suite of products and services to public and private companies, institutional investors, financial institutions and the financial sponsor community. Investment banking and the global markets businesses (fixed income and equities) operate under the Wachovia Securities brand and have become a global force in the capital markets arena by providing comprehensive advisory, capital raising, structuring and execution services. This business also includes the nation's third largest Treasury Services business, as well as asset-based lending, global correspondent banking services and principal investing activities.
2006 Business Fundamentals $6.7 billion total revenue $107.2 billion lending commitments $44.9 billion average loans $26.2 billion average core deposits 3,600 corporate client relationships 2,500 institutional investor relationships
Capital Management
Capital Management leverages its multi-channel distribution to provide a full line of proprietary and nonproprietary investment and retirement products and services to retail and institutional clients. Retail brokerage services are offered through the 2,700 offices of Wachovia Securities in 47 states and Washington, D.C., and through affiliate offices in Latin America. Evergreen Investments, a large and diversified asset management company, provides investment solutions to individuals, institutional investors and endowments. Securities lending services are offered through Metropolitan West Securities, LLC. The Retirement and Investment Products Group is a leading provider of retirement services for individual investors, corporations and plan participants.
2006 Business Fundamentals $6.0 billion total revenue $760.0 billion broker client assets $276.0 billion assets under management $108.0 billion mutual fund assets $168.0 billion separate account assets $110.4 billion retirement plan assets 10,600 registered representatives
Wachovia Corporation 2006 Annual Report
9
General Bank
Average Core Deposit Growth*
(In billions)
Wealth Management
Revenue per Financial Center*
(In millions)
Assets Under Management
(In billions)
Revenue per Relationship Manager
(In millions)
Operating Leverage*
(In billions) Expenses Revenue
Market Position Dominant East Coast presence No. 3 nationwide deposit share No. 1 in Southeast Top 5 in Western U.S. A leading middle-market lender Top 10 U.S. mortgage lender Top 10 auto loan originator No. 4 domestic online bank No. 1 small business and home equity customer satisfaction; mortgage lending ranks N0. 3 (J.D. Power and Associates)
Trust and Investment Management Fee Growth
(In millions)
Market Position 5th largest in wealth market based on Wachovia Securities and Wealth Management assets under management for clients with $1 million or more (Barron’s 2006 survey) Platform Provider of the Year for Advantage (Private Asset Management 2006) Top 5 personal trust provider Top 10 commercial insurance brokerage firm (Business Insurance) Top 5 multifamily office practice (Family Wealth Alliance report)
Value Proposition The General Bank provides deposit, lending and investment products and services for customers at every stage of life, whether they are saving for a home, for a child’s education or for a business ... whether they are building wealth or building a business ... or planning for retirement. The General Bank’s 43,000 sales and service associates and 1,500 commercial and small business relationship managers provide knowledgeable and reliable guidance, whether customers choose to meet with them personally, visit one of our 3,400 financial centers or 5,200 automated teller machines, call our telephone banking center or visit online at wachovia.com. The General Bank also serves the specialized financial needs of businesses large and small with a variety of business checking and savings products, treasury services, global trade services, loans, leases and capital markets products and services.
Value Proposition Wealth Management offers a fully integrated and objective approach that incorporates all the disciplines related to managing our clients’ wealth – from creation and growth to preservation and transfer to future generations. Beginning with a comprehensive financial planning process, a dedicated relationship manager coordinates a team of financial advisors to meet each client’s individual needs. Through a separate, independent practice called Calibre, we also provide sophisticated family office solutions to ultra high net worth families that go beyond meeting financial needs by ensuring each future generation is prepared to be effective stewards of the family’s legacy. Wachovia Insurance Services provides commercial property casualty insurance brokerage, risk management services, employee benefits, life insurance, executive benefits and personal insurance nationwide through 40 offices in 19 states and Washington, D.C.
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Wachovia Corporation 2006 Annual Report
Corporate and Investment Bank
Fee Income Growth
(In billions)
Capital Management
Assets Under Management*
(In billions)
CIB Loan Growth
(In billions)
Brokerage Clients Assets
(In billions)
Significant Growth in Market Share
Based on Fees Generated
Market Position Top 10 in U.S. leveraged finance, high grade, preferred stock and equities Market leader in Real Estate and Structured Products: No. 1 Master Servicer of U.S. CMBS No. 1 in CMBS Fixed Rate Loans No. 3 Lead Manager of U.S. CDOs CMBS Bank of the Year (Real Estate Finance & Investments) No. 1 Stock Pickers – Wachovia Equity Research Team (Forbes) No. 1 correspondent bank for overall institutional satisfaction (FImetrix) Top 3 U.S. asset-based lending lead arranger Top 3 treasury management provider
Annualized Revenue per Series 7 Broker
(In thousands)
Market Position 3rd largest full-service retail brokerage firm 4.2 million broker client accounts 2.1 million participants in retirement plans Top 20 largest mutual fund company (FRC) 2nd largest bank annuity provider based on Kehrer-LIMRA survey 32 Best in Class awards for retirement services (PlanSponsor magazine) 2006 Dalbar Customer Service Award to Evergreen Investments for ninth year
Value Proposition The Corporate and Investment Bank has become a premier partner to corporations and institutional investors through an intense focus on understanding their clients’ needs and delivering innovative solutions through a highly integrated platform. The Corporate and Investment Bank’s integrated team approach and deep industry expertise enable delivery of a breadth of products and services to clients at any stage and in any economic environment. Clients in this arm of Wachovia Securities are middle-market and large-cap companies and private equity investors as well as a broad array of institutional investors around the world. The Corporate and Investment Bank’s 5,700 employees provide Wachovia with a deep pool of relationship coverage officers, product specialists, portfolio managers, and fixed income and equity sales, trading and research professionals.
Value Proposition Capital Management is focused on helping clients achieve a lifetime of financial goals with many choices and resources structured around their individual needs. Our 8,100 financial advisors and 2,500 financial specialists help clients make educated decisions regarding their investments and help them plan their financial future using our proprietary Envision product, with an emphasis on disciplined investing and unbiased advice. Evergreen Investments provides comprehensive investment solutions to individuals, institutions and endowments. Securities lending services are offered through Metropolitan West Securities, LLC. The Retirement and Investment Products Group is a leading provider of retirement services for individual investors, corporations and plan participants, offering individual retirement accounts, variable and fixed annuities, full-service defined contribution, defined benefit and nonqualified plan administration, and reinsurance services.
Wachovia Corporation 2006 Annual Report
11
Guide to Our Financial Discussion
We value our relationship with our investors and pledge to keep you informed about our company. On the following pages, we strive to help you understand more about our financial results, our sources of earnings and our financial condition.
Management’s Discussion and Analysis
Executive Summary Tables on pages 14 and 47 14 We begin with an executive summary of our company and our strategy of balance and diversity in our lines of business. We also summarize our financial results and the underlying trends and factors that affected these results. We discuss our expectations for the future and provide a financial outlook for the upcoming year. We describe the more significant accounting policies that affect our results, and the extent to which we use judgment and estimates in applying those policies. We describe in more detail the topics highlighted in the Executive Summary.
Outlook
15
Critical Accounting Policies
16
Corporate Results of Operations 19, 43 Net interest income and margin (tables on pages 19, 45-47, 49, 59, 60, 66, 77 and 101) Fee and other income (tables on pages 20, 46-47, 49, 66 and 101) Noninterest expense (tables on pages 21, 47, 49, 66 and 101) Merger-related and restructuring expenses (tables on pages 21, 45, 47, 49, 66, 101 and 106) Income taxes (tables on pages 14, 46, 47, 49, 66, 68, 101 and 108) Business Segments Key performance metrics (tables on pages 23-26 and 100-102) General Bank (tables on pages 23 and 100-102) Wealth Management (tables on pages 24 and 100-102) Corporate and Investment Bank (tables on pages 24 and 100-102) Capital Management (tables on pages 25 and 100-102) Parent (tables on pages 26 and 100-102) Balance Sheet Analysis Earning assets (tables on pages 19 and 59-60) Securities (tables on pages 19, 27, 59-60, 65, 68, 76, 81, 82 and 84) Loans (tables on pages 19, 27-28, 50-51, 59-60, 65, 87 and 90) Asset quality (tables on pages 29, 46, 52-54 and 91) Charge-offs (tables on pages 29, 46, 52 and 54) Commercial real estate (tables on pages 27-28 and 50-53) Commitments (tables on pages 23-26 and 101-102) Industry concentrations (table on page 28) Goodwill (tables on pages 55, 65 and 92) 21, 43
Then we review results from our business segments in depth, including the metrics we used to evaluate segment results.
27, 44
The two primary groups of assets that we hold on our balance sheet are securities and loans, which we call earning assets. We discuss these earning assets and related topics such as the mix of our loan portfolio and asset quality here.
Liquidity and Capital Adequacy 30, 44 Core deposits (other deposit tables on pages 19, 56, 59-60 and 68) Purchased funds (tables on pages 19, 59, 60, 65, 68 and 93) Long-term debt (tables on pages 19, 47, 59, 60, 65, 68 and 94) Stockholders' equity (tables on pages 1, 31, 47-49, 65 and 67) Subsidiary dividends (table on page 128) Regulatory capital (tables on pages 46, 58 and 98) Debt ratings Inside Back Cover Off-Balance Sheet Transactions Off-balance sheet summary tables on pages 32, 121 and 126 Risk Management Allowance for loan losses and reserve for unfunded lending commitments (tables on pages 29, 46, 52-53 and 91) Credit risk management Derivatives (tables on pages 112-119) Earnings sensitivity (table on page 39) Interest rate risk management (graph on page 38) Liquidity risk management (table on page 36) Market risk management (graphs on page 35) Operational risk management Trading activities (tables on pages 48, 59-60, 65-66, 68 and 80) 32
Here we describe our funding strategies and our management of liquidity – or the ease with which an asset may be converted into cash at no or little risk, or how funds may be raised in various markets.
We also provide information about our “off-balance sheet” activities such as guarantees and retained interests from securitizations. This section discusses the types of risk to which our business is exposed in the ordinary course of business and our strategies for mitigating that risk.
33
12
Wachovia Corporation 2006 Annual Report
Selected Financial Data Explanation of our use of non-GAAP financial measures Selected statistical data Five-year summaries of income Selected ratios Selected quarterly data Management’s Report on Internal Control over Financial Reporting
45-49
These tables provide often-requested information, including multi-year and quarterly comparisons of our results.
62
In this letter, we affirm our responsibilities related to the reliability of our financial reporting. We are committed to presenting financial results that are complete, transparent and understandable. In these reports, our auditor, KPMG, expresses its independent opinions on our consolidated financial statements and on internal controls over financial reporting. These four statements, and the Notes to Consolidated Financial Statements that accompany them, have been prepared by management and are audited by KPMG, our independent registered public accounting firm.
Reports of Independent Registered Public Accounting Firm
63-64
Consolidated Financial Statements Consolidated balance sheets Consolidated statements of income Consolidated statements of changes in stockholders’ equity Consolidated statements of cash flows Notes to Consolidated Financial Statements Summary of significant accounting policies Business combinations and dispositions Trading account assets and liabilities Securities Variable interest entities, securitizations and retained beneficial interests, and servicing assets Loans, net of unearned income Allowance for loan losses and reserve for unfunded lending commitments Goodwill and other intangible assets Other assets Short-term borrowings Long-term debt Common and preferred stock and capital ratios Accumulated other comprehensive income, net Business segments Personnel expense and retirement benefits Merger-related and restructuring expenses Income taxes Basic and diluted earnings per common share Derivatives Commitments, guarantees, litigation and other regulatory matters Fair value of financial instruments Wachovia Corporation (parent company) Ratios Capital and leverage (tables on pages 46 and 58) Common stockholders’ equity to assets (table on page 49) Dividend payout ratio (tables on pages 1, 45 and 48) Economic profit (tables on pages 23-26) Efficiency ratio (tables on pages 23-26) Net interest margin (table on page 60) Profitability (ROA and ROE) (tables on pages 46, 48 and 49) Risk-adjusted return on capital (tables on pages 23-26) Glossary of Financial Terms Geographic Reach Board of Directors and Operating Committee Stockholder Information
65-68
69-129
In these notes, we describe the policies we use in accounting for our assets, liabilities and operating activities. We also discuss our significant acquisitions and divestitures and provide additional information about our primary assets, including securities and loans, and funding sources, such as short-term borrowings and long-term debt, along with our off-balance sheet commitments. Specific details are included for our stock-based compensation, income taxes and business segments. We believe you will find useful information to help you more fully understand our financial statements in these disclosures, which are provided to meet accounting and reporting requirements and are presented in stipulated formats.
45-49 31 15 22 16 19 22 130 131 132 Inside Back Cover
Throughout this document, we provide information about the key performance indicators by which we measure our success in driving shareholder value, including measures that serve as benchmarks for our management team’s compensation.
More definitions to help you understand our businesses. Includes market share and market rank in our banking states. These are the people who lead our company. We end with information about our Annual Meeting, how to contact us, and for our fixed income investors, we provide a summary table of our debt ratings.
Wachovia Corporation 2006 Annual Report
13
Management’s Discussion and Analysis
The following discussion and analysis is based primarily on amounts presented in our consolidated financial statements, which are prepared in accordance with U.S. generally accepted accounting principles, or GAAP. This discussion contains forward-looking statements. Please refer to our 2006 Annual Report on Form 10-K for a discussion of various factors that could cause our actual results to differ materially from those expressed in such forward-looking statements. Summary Results of Operations
Years Ended December 31,
(In millions, except per share data)
and capital markets financing alternatives for institutional and corporate clients. This business mix produces revenue from the interest income earned on loans and securities, as well as fee income from faster-growth but less predictable asset management, retail brokerage and investment banking businesses. Fee and other income represented 49 percent of total revenue in 2006 compared with 47 percent in 2005. Wachovia’s net income in 2006 was $7.8 billion, up 17 percent from 2005, and diluted earnings per common share were up 11 percent to $4.63. After-tax net merger-related and restructuring expenses were 7 cents per share in 2006 and 11 cents per share in 2005. Results reflect the impact of acquisitions from the date on which each closed, including Golden West Financial Corporation of Oakland, California, from October 1, 2006, and Westcorp and WFS Financial of Irvine, California (collectively Westcorp), from March 1, 2006. Golden West is the parent of World Savings Bank, FSB, with a retail branch presence primarily in the Western United States and mortgage lending operations in 39 states. Westcorp is an auto dealer financial services business that covers 46 states and also has a small retail branch network in California. In addition, results reflect divestitures of our Corporate and Institutional Trust businesses in late 2005 and our subprime mortgage servicing operation in late 2006. In addition, key factors in 2006 compared with 2005 included: 15 percent revenue growth driven by a 19 percent increase in fee and other income largely from our market-driven businesses, as well as growth in service charges, other banking fees and other income. Net interest income growth of 11 percent reflecting a larger balance sheet, although growth was dampened by margin compression. Average loans grew 35 percent, including the addition for three months of $124.0 billion from Golden West and the addition for 10 months of $13.5 billion from Westcorp. 10 percent growth in noninterest expense, reflecting the impact of acquisitions on personnel expense, revenuerelated and other incentives and efficiency initiative costs. Wachovia is one of the nation’s largest lenders, and the credit quality of our loan portfolio can have a significant impact on earnings. Our credit quality remained among the best in the banking industry in 2006, with a net charge-off ratio of 0.12 percent and a ratio of nonperforming assets to loans, net, foreclosed properties and loans held for sale of 0.32 percent. Provision expense increased 74 percent to $434 million, largely reflecting the Westcorp acquisition and organic loan growth. We continue to mitigate risk and volatility on our balance sheet by actively monitoring and reducing potential problem loans, including their sale when prudent. We are optimistic about our outlook for credit quality as we enter 2007 given the highly collateralized
2006 $ 15,249 155 15,404 14,545 29,949 434 16,874 179 423 17,476 414 3,725 155 7,745 46 $ $ $ 7,791 4.61 4.63
2005 13,681 219 13,900 12,219 26,119 249 15,139 292 416 15,847 342 3,033 219 6,429 214 6,643 4.05 4.19
2004 11,961 250 12,211 10,779 22,990 257 13,791 444 431 14,666 184 2,419 250 5,214 – 5,214 3.81 3.81
Net interest income (GAAP) Tax-equivalent adjustment Net interest income Total revenue
(a) (a)
Fee and other income Provision for credit losses Other noninterest expense Merger-related and restructuring expenses Other intangible amortization Total noninterest expense Minority interest in income of consolidated subsidiaries Income taxes Tax-equivalent adjustment Income from continuing operations Discontinued operations, net of income taxes Net income Diluted earnings per common share from continuing operations Diluted earnings per common share based on net income
(a)
Tax-equivalent.
Executive Summary
Our earnings are primarily generated through four core businesses, two of which largely conduct traditional banking activities -- the General Bank and Wealth Management – and two with businesses that are largely related to financial market activities -- the Corporate and Investment Bank and Capital Management. In the following discussion, we explain this diverse group of businesses and why we believe our shareholders and customers benefit from this balance and diversity. In addition, throughout this document, we address key performance indicators of our financial position and results of operations that drive shareholder value and serve as benchmarks to compensate management. We discuss trends and uncertainties affecting our businesses, and analyze liquidity and capital resources. Our business model is based on a mix of businesses that provide a broad range of financial products and services, delivered through multiple distribution channels. This means that in addition to the typical lending and deposittaking activities of traditional banking companies, we also offer investment products and services for retail customers,
14
Wachovia Corporation 2006 Annual Report
nature of our loan portfolio. While we expect modest increases in credit costs, we believe overall credit quality will remain strong. The 35 percent increase from 2005 in average net loans to $307.7 billion included average consumer loan growth of 67 percent, driven by the addition of an average balance of $31.7 billion from Golden West and of $12.1 billion from Westcorp, and the transfer of $12.5 billion of home equity lines to the loan portfolio from loans held for sale at yearend 2005. Excluding these effects, average consumer loans increased 8 percent, reflecting increased consumer real estate secured activity. In addition, loans reflected organic growth in middle-market commercial and commercial real estate construction lending, large corporate lending and international lending. Average core deposits increased 11 percent from 2005 to $309.0 billion, including the average balance impact of $17.2 billion from Golden West, and average low-cost core deposits increased 2 percent from 2005 to $244.2 billion. Our four major businesses continued to generate strong sales activity and market share gains in 2006. The General Bank’s earnings rose 37 percent to $5.2 billion, reflecting the addition of Golden West and Westcorp, as well as organic growth. Wealth Management’s earnings grew 8 percent to $267 million and reflected the introduction of a new investment platform. Our Corporate and Investment Bank increased earnings 15 percent to $2.0 billion, reflecting strong investment banking results, primarily real estate capital markets and client origination activity, as well as higher principal investing results. Capital Management grew earnings 34 percent to $931 million, reflecting a strong focus on growing retail brokerage managed account fees as well as higher net interest income as deposit spreads improved. Controlling expense growth and improving revenue growth continue to be a strategic focus, with our business units and the company progressing in 2006 toward overhead efficiency targets for 2007. Noninterest expense in 2006 included $81 million relating to our efficiency initiatives. Further information about our goals for improving efficiency is in the Outlook section. We have expanded our focus on consumer lending, particularly in mortgage, auto and credit card. We also continue to enhance the efficiency of our financial center network and expand our presence in higher growth markets. This has resulted in higher expenses, largely in the General Bank. In 2006, we opened 85 de novo (or new) branches, consolidated 152 branches and expanded our commercial banking presence, which increased noninterest expense by $96 million. In January 2006, we reentered the credit card business with a focus on our existing customers and received a $100 million credit card-related MBNA termination fee. In 2006, noninterest expense associated with the credit card
business amounted to $50 million and the provision for credit losses in the Parent segment included $38 million related to credit card outstandings. In June 2006, we announced the divestiture of our subprime mortgage servicing business, HomEq Servicing. This transaction closed on November 1, 2006, for proceeds of $489 million, and disposition-related costs of $41 million were recorded as merger-related and restructuring expenses. In December 2006, we reported as discontinued operations an additional $46 million after-tax gain related to the divestiture of Corporate and Institutional Trust businesses in the fourth quarter of 2005. We paid common stockholders dividends of $3.6 billion, or $2.14 per share, in 2006, and $3.0 billion, or $1.94 per share in 2005. Our target is to return 40 percent to 50 percent of our earnings to shareholders as dividends, and in 2006, our dividend payout ratio was 46.22 percent, or 44.21 percent excluding merger-related and restructuring expenses, other intangible amortization and discontinued operations, which is the basis we use in measuring our goal. Our balance sheet is strong and well capitalized under regulatory guidelines with a tier 1 capital ratio of 7.42 percent, a leverage ratio of 6.01 percent and a tangible capital ratio of 4.45 percent at December 31, 2006. The adoption of FIN 48 and FSP 13-2, both effective on January 1, 2007, reduced these same capital measurements by approximately 27 basis points for the tier 1 capital ratio, 22 basis points for the leverage ratio and 21 basis points for the tangible capital ratio. We remain focused on maintaining our capital ratio targets, some of which are measured on a different basis, as discussed in the Outlook section. FIN 48 and FSP 13-2 are defined and explained in the Accounting and Regulatory Matters section.
Outlook
Based on our consistent performance, confidence in our business model and our capital strength, we have updated our financial outlook for 2007. This outlook computes growth rates from an illustrative combined Wachovia and Golden West as if the two companies had been merged on January 1, 2006. This illustrative combined 2006 basis includes Wachovia full year 2006 results before merger-related and restructuring expenses, plus Golden West’s results from January 1, 2006, to September 30, 2006. These combined results add purchase accounting and other closing adjustments to Golden West’s results prior to the closing date. In addition, these results include funding costs, which represent interest expense calculated at a rate of 5.35 percent on the cash portion of the purchase price. The illustrative combined basis also excludes certain immaterial fourth quarter 2006 adjustments, which are described in more detail in applicable Notes to Consolidated Financial Statements, and the effect of Golden West’s third quarter 2006 charitable contribution
Wachovia Corporation 2006 Annual Report
15
Management’s Discussion and Analysis
of appreciated securities. The effect of Golden West’s contribution in their pre-merger results was an increase in fee and other income of $367 million, an increase in noninterest expense of $372 million and a decrease in income taxes of $130 million. Additionally, this outlook reflects our expectations before the effect of implementation of FIN 48 and FSP 13-2 as outlined in more detail below and in the Accounting and Regulatory Matters section. For full year 2007 compared with full year illustrative combined 2006, and before merger-related and restructuring expenses, we expect: Net interest income growth in the low single-digit percentage range on a tax-equivalent basis compared with $18.1 billion. Fee income growth in the low double-digits percentage range from $14.5 billion. Noninterest expense growth in the mid single-digit percentage range from $18.1 billion. Minority interest expense increase in the high singledigit percentage range from $414 million. Loan growth in the high single-digit percentage range from $398.4 billion, including consumer loan growth in the low double-digits percentage range from $249.6 billion, and commercial loan growth in the mid single-digit percentage range from $148.8 billion. Net charge-offs in the mid-teens basis point range as a percentage of average net loans, up from 8 basis points; and provision expense may be modestly higher. An effective income tax rate in the range of 33.5 percent to 34 percent on a tax-equivalent basis. A targeted leverage ratio above 6.0 percent and a tangible capital to tangible asset ratio no lower than 4.7 percent, excluding the effect on tangible capital of the unrealized gains and losses on available for sale securities and certain risk management derivatives, and the pension accounting adjustment discussed in the Stockholders’ Equity section. A dividend payout ratio of 40 percent to 50 percent of earnings before other intangible amortization. Use of excess capital to opportunistically repurchase shares, to reinvest in our businesses and to undertake financially attractive, shareholder-friendly acquisitions. In addition, we expect the implementation of FSP 13-2 will reduce 2007 net interest income by $75 million and increase
income taxes by a net $16 million. Further, the impact on stockholders’ equity of the adoption of FSP 13-2 will lower the 2007 tangible capital to tangible asset ratio, which was 4.75 percent as measured on the above basis at December 31, 2006, by approximately 21 basis points. While this tangible capital ratio, including the effect of adoption of FSP 13-2, will temporarily be below our targeted levels, we believe it is reasonable to operate below those targets for an interim period, and we intend to deploy a balanced approach between rebuilding capital to targeted levels and using capital in other activities as outlined above. We continue to evaluate our operations and organizational structures to ensure they are closely aligned with our goal of maximizing performance through increased efficiency and competitiveness in our four core businesses. We are striving to make Wachovia a more efficient company, but it is not our intention to have the lowest overhead efficiency ratio in our peer group because we expect to continue to invest in higher growth businesses. In January 2005, we set a goal of reducing our annual expense growth by $600 million to $1.0 billion by the end of 2007. We have identified expense reduction opportunities that are expected to result in incremental cost savings of approximately $200 million in 2007 for total annual savings at the high end of our goal. Our efficiency efforts include enhancing the effectiveness of our branch network. We expect to consolidate up to 100 branches and open up to 130 branches in 2007. As a result of our merger with Golden West, we have revised our year-end 2007 targeted overhead efficiency ratio for the overall company to 51.5 percent to 53.5 percent excluding merger-related and restructuring expenses, and other intangible amortization. Because our business mix has changed largely due to merger activity, we have not set revised targets for our four business segments. We also will focus on ensuring successful integration of Westcorp and Golden West and have begun deposit system conversions in California with Westcorp, which was completed in the first quarter of 2007. Golden West deposit system conversions are expected to begin in the fourth quarter of 2007 and be completed by mid-2008. When consistent with our overall business strategy, we may consider disposing of certain assets, branches, subsidiaries or lines of business. We continue to routinely explore acquisition opportunities in areas that would complement our core businesses, and frequently conduct due diligence activities in connection with possible acquisitions. As a result, acquisition discussions and, in some cases, negotiations frequently take place and future acquisitions involving cash, debt or equity securities could occur.
Critical Accounting Policies
Our accounting and reporting policies are in accordance with GAAP and they conform to general practices within
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Wachovia Corporation 2006 Annual Report
the applicable industries. We use a significant amount of judgment, and estimates based on assumptions for which the actual results are uncertain when we make the estimations. We have identified five policies as being particularly sensitive in terms of judgments and the extent to which significant estimates are used: allowance for loan losses and the reserve for unfunded lending commitments (which is recorded in other liabilities); fair value of certain financial instruments; consolidation; goodwill impairment; and contingent liabilities. Other accounting policies, such as pension liability measurement and stock option fair value determination, also involve a significant amount of judgment and estimates, but the impact of the estimates involved is not significant to our consolidated results of operations. The Audit Committee of our board of directors reviews these policies, the judgment and estimation processes involved, and related disclosures. Our policy on the allowance for loan losses applies to all loans, but is different from the methodology used to allocate the provision for credit losses for segment reporting purposes, which is discussed in applicable Notes to Consolidated Financial Statements. The policy on fair value of certain financial instruments applies largely to the Corporate and Investment Bank and the Parent, both of which hold large portfolios of securities and derivatives. The policy on consolidation also affects the Corporate and Investment Bank and the Parent, both of which are involved in structuring securitization transactions. The policies on goodwill impairment and contingent liabilities affect all segments. Allowance for Loan Losses and Reserve for Unfunded Lending Commitments The allowance for loan losses and reserve for unfunded lending commitments, which we refer to collectively as the allowance for credit losses, are maintained at levels we believe are adequate to absorb probable losses inherent in the loan portfolio and unfunded lending commitments as of the date of the consolidated financial statements. We monitor qualitative and quantitative trends, including changes in the levels of past due, criticized and nonperforming loans. In addition, we rely on estimates and exercise judgment in assessing credit risk. We employ a variety of modeling and estimation tools for measuring credit risk. These tools are periodically reevaluated and refined as appropriate. The following provides a description of each component of our allowance for credit losses, the techniques we currently use and the estimates and judgments inherent to each. Our model for the allowance for loan losses has four components: formula-based components for both the commercial and consumer portfolios, each including an adjustment for historical loss variability; a reserve for impaired commercial loans; and an unallocated component.
For commercial loans, the formula-based component of the allowance for loan losses is based on statistical estimates of the average losses observed by credit grade. Average losses for each credit grade reflect the annualized historical default rate and the average losses realized for defaulted loans. For consumer loans, the formula-based component of the allowance for loan losses is based on statistical estimates of the average losses observed by product classification. Average losses for each product class are computed using historical loss data, including analysis of delinquency patterns, origination vintage and various credit risk forecast indicators. For both commercial and consumer loans, the formula-based components include additional amounts to establish reasonable ranges that consider observed historical variability in losses. Factors we may consider in setting these amounts include, but are not limited to, industry-specific data, portfolio-specific risks or concentrations, and macroeconomic conditions. At December 31, 2006, the formula-based components of the allowance were $1.9 billion for commercial loans and $1.3 billion for consumer loans, compared with $1.9 billion and $730 million, respectively, at December 31, 2005. The increase in the consumer component reflects the Golden West and Westcorp acquisitions. We have established a specific reserve within the allowance for loan losses for impaired loans. We define impaired loans as commercial loans on nonaccrual status. We individually review any impaired loan with a minimum total exposure of $10 million in the Corporate and Investment Bank and $5 million in other segments. The reserve for each individually reviewed loan is based on the difference between the loan’s carrying amount and the loan’s estimated fair value. No other reserve is provided on impaired loans that are individually reviewed. At December 31, 2006, the allowance for loan losses included $14 million and the reserve for unfunded lending commitments included $5 million for individually reviewed impaired loans and facilities. At December 31, 2005, these amounts were $10 million and $7 million, respectively. The allowance for loan losses is supplemented with an unallocated component, which reflects the inherent uncertainty of our estimates. The amount of this component and its relationship to the total allowance for loan losses may change from one period to another as facts and circumstances dictate. We anticipate the unallocated component of the allowance will generally not exceed 5 percent of the total allowance for loan losses. At December 31, 2006, the unallocated component of the allowance for loan losses was $160 million, or 5 percent of the allowance for loan losses, compared with $135 million, or 5 percent, at December 31, 2005. The reserve for unfunded lending commitments, which relates only to commercial business, is based on a modeling
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Management’s Discussion and Analysis
process that is consistent with the methodology described above for the commercial portion of the allowance. In addition, this model includes as a key factor the historical average rate at which unfunded commercial exposures have been funded at the time of default. At December 31, 2006 and 2005, the reserve for unfunded lending commitments was $154 million and $158 million, respectively. The factors supporting the allowance for loan losses and the reserve for unfunded lending commitments as described above do not diminish the fact that the entire allowance for loan losses and reserve for unfunded lending commitments are available to absorb losses in the loan portfolio and related commitment portfolio, respectively. Our principal focus, therefore, is on the adequacy of the total allowance for loan losses and reserve for unfunded lending commitments. Additionally, our primary bank regulators regularly conduct examinations of the allowance for credit losses and make assessments regarding its adequacy and the methodology employed in its determination. Fair Value of Certain Financial Instruments Fair value is defined as the amount at which a financial instrument could be exchanged in a transaction between willing, unrelated parties in a normal business transaction. Financial instruments recorded at fair value include: Instruments held for trading, including debt and equity securities and derivatives, with unrealized gains and losses recorded in earnings. Debt and equity securities and retained interests in securitizations classified as available for sale, with unrealized gains and losses recorded in stockholders’ equity. Derivatives designated as fair value or cash flow accounting hedges, with unrealized gains and losses recorded in earnings for fair value hedges and stockholders’ equity for cash flow hedges. Principal investments, which are classified in other assets and which include public equity and private investments, with realized and unrealized gains and losses recorded in earnings. In addition, the determination of fair value affects loans held for sale, which are recorded at the lower of cost or market value, with any changes in value recorded in earnings. If market prices are not available, we estimate fair value using models employing techniques such as discounted cash flow analyses. The assumptions used in the models, which typically include assumptions for interest rates, credit losses and prepayments, are independently verified against market observable data where possible. Where market observable data is not available, the valuation of
financial instruments becomes more subjective and involves a high degree of judgment. Certain principal investments are recorded at values such that gains are not recorded until certain events confirm the value has changed, such as a subsequent round of funding by the investee or receipt of distributions from private equity funds. At December 31, 2006, 22 percent of our total assets and 3 percent of our total liabilities were recorded at fair value. Of this total, 77 percent were valued using quoted market prices, vendor prices or third party broker quotations for the same or similar securities; 21 percent using modeling techniques where the significant assumptions were based on market observations; and 2 percent using modeling techniques where significant assumptions were based on internal estimates rather than market observations. In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements, (SFAS 157), which establishes a framework for measuring fair value under U.S. GAAP, expands disclosure about fair value measurement and provides new income recognition criteria for certain derivative contracts. SFAS 157 is required to be implemented on January 1, 2008. The Accounting and Regulatory Matters section has additional information about this new standard. Consolidation In certain asset securitization transactions that meet the applicable criteria to be accounted for as sales, we sell assets to an entity referred to as a qualifying special purpose entity (QSPE), which we do not consolidate. In order for a special purpose entity to be considered a QSPE, it must meet a series of requirements at the inception of the transaction and on an ongoing basis. These requirements strictly limit the activities in which a QSPE may engage and the types of assets and liabilities it may hold. In some cases, these criteria are subject to interpretation. To the extent any QSPE fails to meet these criteria, we may be required to consolidate its assets and liabilities. We also sell assets to and have involvement with other special purpose entities, some of which are variable interest entities (VIE). These include certain financing activities primarily conducted for corporate clients, including conduits that we administer, transactions such as collateralized debt obligations and collateralized mortgage obligations, partnerships, synthetic lease trusts and trust preferred securities. Under the provisions of FASB Interpretation No. 46 (revised), Consolidation of Variable Interest Entities (FIN 46R), a VIE is consolidated by a company holding the variable interest that will absorb a majority of the VIE’s expected losses, or receive a majority of the expected residual returns, or both. The company that consolidates a VIE is referred to as the primary beneficiary.
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A variety of complex estimation processes involving both qualitative and quantitative factors are used to determine whether an entity is a VIE, and to analyze and calculate its expected losses and its expected residual returns. These processes involve estimating the future cash flows of the VIE, analyzing the variability in those cash flows, and allocating the losses and returns among the parties holding variable interests. This involves a significant amount of judgment in interpreting the provisions of FIN 46R and other related guidance and applying them to specific transactions. The FASB has a project under way addressing what activities a QSPE may perform. The outcome of this project may affect the entities we consolidate in future periods. The Accounting and Regulatory Matters section has additional information on this FASB project. Goodwill Impairment We test goodwill for impairment on an annual basis, or more often if events or circumstances indicate there may be impairment. If the carrying amount of reporting unit goodwill exceeds its implied fair value, we would recognize an impairment loss in an amount equal to that excess. As discussed in the Business Segments section, we operate in four core business segments. Our reporting units for testing goodwill are our lines of business that are one level below the core business segments, where applicable. These reporting units are General Bank: Commercial, and Retail and Small Business; Wealth Management; Corporate and Investment Bank: Corporate Lending, Treasury and International Trade Finance, and Investment Banking; and Capital Management: Retail Brokerage Services and Asset Management. Fair values of reporting units in 2006 were determined using two methods, one based on market earnings multiples of peer companies for each reporting unit, and one based on discounted cash flow models with estimated cash flows based on internal forecasts of revenues and expenses. The earnings multiples for the first method ranged between 11.2 times and 20.5 times. The estimated cash flows for the second method were discounted using market-based discount rates ranging from 10.4 percent to 13.9 percent. Our goodwill impairment testing for 2006 indicated that none of our goodwill was impaired. Applicable Notes to Consolidated Financial Statements provide additional information. Contingent Liabilities We are subject to contingent liabilities, including judicial, regulatory and arbitration proceedings, tax and other claims arising from the conduct of our business activities. These proceedings include actions brought against us and/or our subsidiaries with respect to transactions in which we and/or our subsidiaries acted as a lender, an underwriter, a financial advisor, a broker, or in a related capacity. Reserves are established for legal and
other claims when it becomes probable we will incur a loss and the amount can be reasonably estimated. Changes in the probability assessment can lead to changes in recorded reserves. In addition, the actual costs of resolving these contingencies may be substantially higher or lower than the amounts reserved for these claims. Applicable Notes to Consolidated Financial Statements provide more information.
Corporate Results of Operations
Results reflect the impact of Golden West and Westcorp only from the dates on which each merger closed, and the divestitures described above. Average Balance Sheets and Interest Rates
Years Ended December 31, 2006
(In millions)
2005 Average Balances $ 2,516 24,008 33,800 115,107 132,504 95,418 227,922 15,293 9,944 – 428,590 242,152 54,302 11,898 10,279 6,675 47,774 – 373,080 $ 13,900 Interest Rates 3.23% 3.31 4.94 5.14 5.69 5.81 5.74 5.71 5.36 0.23 5.58 2.00 3.08 3.05 3.31 1.87 4.46 0.14 2.68 3.24%
Average Balances $ 2,793 18,911 29,695 118,170 148,459 159,263 307,722 10,428 6,343 – 494,062 279,144 48,457 4,775 9,168 6,431 87,178 – 435,153 $ 15,404
Interest Rates 5.16% 4.82 5.44 5.38 6.91 7.18 7.05 6.78 7.54 0.11 6.56 3.20 4.56 4.50 3.41 2.26 5.28 0.13 3.91 3.12%
Interest-bearing bank balances Federal funds sold Trading account assets Securities Commercial loans, net Consumer loans, net Total loans, net Loans held for sale Other earning assets Risk management derivatives Total earning assets Interest-bearing deposits Federal funds purchased Commercial paper Securities sold short Other short-term borrowings Long-term debt Risk management derivatives Total interest-bearing liabilities Net interest income and margin
Net Interest Income and Margin We earn net interest income on the difference between interest income on earning assets, primarily loans and securities, and interest expense on interest-bearing liabilities, primarily deposits and other funding sources. Tax-equivalent net interest income increased 11 percent in 2006 from 2005, reflecting a larger balance sheet. The net interest margin declined 12 basis points to 3.12 percent, primarily due to growth in lower spread loans and other assets, lower trading-related net interest income, a modest shift in deposits to lower spread categories and the impact of an inverted yield curve. The Westcorp acquisition added a large portfolio of higher spread consumer loans for 10 months of 2006 while the October acquisition of Golden West added lower spread consumer real estate-secured loans. Growth in retail, small business and commercial deposits was somewhat offset
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Management’s Discussion and Analysis
by decreases in retail brokerage deposits. The average federal funds rate in 2006 was 175 basis points higher than the average rate for 2005, while the average longerterm two-year treasury note rate increased 97 basis points and the average 10-year treasury note rate increased 50 basis points. In order to maintain our targeted interest rate risk profile, derivatives are often used to manage the interest rate risk inherent in our assets and liabilities. We routinely deploy hedging strategies designed to protect future net interest income. These strategies may reduce current income in the short-term, although we expect them to benefit future periods. In 2006, net interest rate risk management-related derivatives reduced net interest income by $55 million, or 1 basis point on our net interest margin, compared with an income contribution of $432 million, or 10 basis points, in 2005. The decline in the impact from derivatives largely reflects deposit growth, the effect of receive fixed/pay floating interest rate swaps in a rising rate environment, and greater use of cash securities instead of derivatives to maintain our targeted interest rate risk profile. Fee and Other Income
Years Ended December 31,
(In millions)
Increased service charges and other banking fees driven by strength in consumer service charges and higher interchange income on higher rates and increased volume. A modest increase in commissions reflecting growth in insurance commissions, including the impact of acquisitions, and flat retail brokerage commissions as customers migrated to retail brokerage managed account relationships. Strong growth in retail brokerage managed account assets, which drove higher fiduciary and asset management fees. This growth was offset by lower trust fees from the divestiture of our Corporate and Institutional Trust businesses in late 2005. Strong results in advisory and underwriting largely related to record performance in real estate capital markets, merger and acquisition advisory services, equities underwriting, investment grade debt and loan syndications. Stronger trading account profits with increases in global rate products and leveraged finance.
2006 $ 2,480 1,756 2,406 3,248 1,345 535 525 118 2,132 $ 14,545
2005 2,151 1,491 2,343 3,011 1,109 286 401 89 1,338 12,219
2004 1,978 1,226 2,554 2,819 911 151 261 (10) 889 10,779
Service charges Other banking fees Commissions Fiduciary and asset management fees Advisory, underwriting and other investment banking fees Trading account profits Principal investing Securities gains (losses) Other income Total fee and other income
Higher principal investing income related to our strong results in the fund portfolio, which included higher realized gains and a second quarter 2006 unrealized gain of $116 million on the sale of an interest in certain fund investments, while results in the direct portfolio declined $36 million. Net securities gains of $118 million, of which $75 million related to the corporate portfolio, including the fourth quarter securitization of certain residual interests, and $34 million related to our Corporate and Investment Bank corporate lending activities. Increased other income including $311 million of higher income related to commercial mortgage securitization activity, which was included in trading account profits prior to 2006; the $100 million MBNA termination fee; a $93 million fourth quarter 2006 adjustment for certain discontinued hedging relationships; $74 million related to continued servicing of the divested Corporate and Institutional Trust businesses; and a $68 million increase in consumer asset sale and securitization income. In 2005, there was a gain of $122 million from the sale of equity securities received in settlement of loans. Noninterest Expense Noninterest expense increased 10 percent in 2006 from 2005, largely reflecting acquisition activity. In addition, expenses reflected higher revenuebased and other incentives; $198 million in fourth quarter 2006 adjustments for additional accruals for employee paid time off and for certain other sundry expenses; a $107 million increase in employee stock compensation,
Fee and Other Income Traditionally banks earn fee and other income from service charges on deposit accounts and other banking products and services, and these continue to be a significant component of our fee income. In addition, we have balanced our earnings with a diversified mix of businesses that provide alternative investment and financing products and services for the more sophisticated needs of our clients. These alternative products produce income in our brokerage, asset management and investment banking businesses from commissions and fees for financial advice, custody, insurance, loan syndications and asset securitizations. Additionally, we realize gains when we sell our investments in debt and equity securities. The fees on many of these products and services are based on market valuations and therefore are sensitive to movements in the financial markets. Fee and other income growth of 19 percent in 2006 from 2005 came in every category, and reflected:
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Wachovia Corporation 2006 Annual Report
Noninterest Expense
Years Ended December 31,
(In millions)
2006 $ 10,903 1,173 1,184 204 653 790 1,967 16,874 179 423 $ 17,476
2005 9,671 1,064 1,087 193 633 662 1,829 15,139 292 416 15,847
2004 8,703 947 1,052 193 620 548 1,728 13,791 444 431 14,666
Salaries and employee benefits Occupancy Equipment Advertising Communications and supplies Professional and consulting fees Sundry expense Other noninterest expense Merger-related and restructuring expenses Other intangible amortization Total noninterest expense
Merger-Related and Restructuring Expenses Merger-related and restructuring expenses in 2006 of $179 million included $64 million related to SouthTrust, which is now completed; $41 million related to the HomEq servicing business divestiture; $40 million related to Golden West; and $34 million related to other acquisitions. In 2005, we recorded $292 million of these expenses, of which $227 million related to SouthTrust, $63 million related to the retail brokerage integration, and $2 million related to the Palmer & Cay commercial insurance brokerage acquisition. Income Taxes Income taxes based on income from continuing operations were $3.7 billion in 2006, an increase of $692 million from 2005. The related effective income tax rates were 32.49 percent in 2006 and 32.05 percent in 2005. The increase in this rate was primarily the result of higher pretax income in 2006. On a fully tax-equivalent basis, the related income tax rates were 33.39 percent in 2006 and 33.59 percent in 2005.
which is included in salaries and employee benefits; and costs related to our de novo expansion and efficiency initiatives. A favorable resolution of franchise tax matters partially offset the increase in noninterest expense. We grant stock-based awards to employees in the form of stock options and restricted stock. We adopted the fair value method of accounting for stock options in 2002, and salaries and employee benefits expense included $522 million in 2006 and $333 million in 2005 related to options and restricted stock. The employee stock compensation expense increase related to the implementation of a new share-based payment accounting standard, which applied to annual stock awards beginning in 2006. The increased expense is primarily due to the impact of awards granted to retirement-eligible employees. These awards are now expensed in full at the date of the grant rather than over the full contractual threeto five-year vesting period. Applicable Notes to Consolidated Financial Statements have additional information. We sponsor a defined benefit pension plan for our employees, and salaries and employee benefits expense included $136 million in 2006 and $65 million in 2005 of retirement benefits cost for this plan. This expense reflected estimated returns on the plan assets of 8.5 percent in 2006 and 2005, while actual returns were 8.9 percent and 11.7 percent, respectively. In accordance with current accounting principles, the differences between estimated and actual returns are deferred, and along with other amounts, are recognized over the estimated remaining service periods of the plan participants. At December 31, 2006, we had deferred net losses and other items of $1.6 billion, which will be recognized as a component of retirement benefits cost over the next 12 years on a straight-line basis. Applicable Notes to Consolidated Financial Statements have additional information related to this and other pension and post-retirement plans, including how we determine the key assumptions used to measure the benefit obligation and retirement benefits expense. The funding of our pension obligation does not represent a significant liquidity commitment for us.
Business Segments
We provide diversified banking and nonbanking financial services and products primarily through four core business segments, the General Bank, Wealth Management, the Corporate and Investment Bank, and Capital Management. In this section, we discuss the performance and results of these core business segments and the Parent in 2006 compared with 2005. The Comparison of 2005 with 2004 section has details on business segment trends over that period. We originate and securitize commercial loans, principally commercial mortgages, and consumer loans, including consumer real-estate secured, mortgage, auto and student loans. The General Bank results include sales and securitizations of mortgage loans, where we generally do not retain significant interests, other than servicing rights, and gains on sales are included in other fee income. The Corporate and Investment Bank results include securitizations of commercial loans, with gains reflected in other fee income and, prior to 2006, in trading. We generally retain servicing rights on commercial loan securitizations, but not significant retained interests. In addition, the Corporate and Investment Bank securitizes assets on behalf of customers for whom we may have warehoused the collateral on our balance sheet prior to the transaction. Gains and losses on these transactions are recorded in trading account profits, along with any gains or losses on the assets while we held them. The Parent results include securitizations of other consumer loans in which we have retained interests and/or servicing rights. Gains and losses on these consumer loan securitizations are recorded in other fee income. Certain of these consumer loans are included in the General Bank results as if they had not been securitized; the Parent results include the impact of de-recognizing these loans from the consolidated balance sheet by recording a negative, or contra, loan balance.
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Management’s Discussion and Analysis
Business segment data excludes merger-related and restructuring expenses, other intangible amortization, the gain on sale of discontinued operations and the effect of changes in accounting principle. Applicable Notes to Consolidated Financial Statements discusses in detail the management reporting model on which our segment information is based and also provides a reconciliation of business segment earnings to the consolidated results of operations. Key Performance Metrics Business segment earnings are the primary measure of segment profit or loss we use to assess segment performance and to allocate resources. Economic profit, risk-adjusted return on capital (RAROC) and efficiency ratios are additional metrics, all of which are based on and calculated directly from segment earnings, that assist management in evaluating segment results. The first two measures are calculated as follows:
Economic Profit = Economic Net Income – Capital Charge RAROC = Economic Net Income / Economic Capital
Market Risk: The major components of market risk, which represented 20 percent of economic capital in 2006, are interest rate risk inherent in our balance sheet, price risk in our principal investing portfolio and market value risk in our trading portfolios. Operational, Business and Other Risk: Operational risk is the risk of loss from inadequate or failed internal processes, people and systems or from external events. This risk is inherent in all our businesses. Business risk is the potential losses our business lines could suffer that have not been captured elsewhere (such as losses from a difficult business environment). Business and operational risk capital are the primary types of capital held by non-balance sheet intensive businesses such as trust, asset management and brokerage. Other risk represents the loss in value that other miscellaneous and fixed assets could realize that are not captured as market risk. Operational, business and other risk represented 24 percent of our economic capital in 2006. Our economic capital models are calibrated to achieve a standard of default protection equivalent to a “AA” rated institution. These models were developed to determine economic capital under a consistent, specific, internal definition of risk (that is, uncertainty in economic value). Accordingly, our required aggregate economic capital can be materially different from other capital measures developed under GAAP, regulatory or rating agency frameworks. We measure the financial returns achieved by a transaction or business unit after deducting a charge for the economic capital required to support the risks taken. We calculate this charge by multiplying the attributed economic capital times the cost of our equity capital (derived through a capital asset pricing model approach). Since 2002, the cost of capital has been 11 percent. The cost of capital is reviewed annually by our treasury division and approved by the RAROC Advisory Committee, which is a subcommittee of the Asset and Liability Management Committee. The Risk Governance section has more information about these committees. We use RAROC and economic profit measures in a variety of ways. They are used in the pricing of transactions such as loans, commitments and credit substitutes in each of our business segments. These transactional measures are aggregated to provide portfolio, business line, and ultimately business segment RAROC and economic profit measures. Incremental activities such as new product analysis, business line extensions and acquisitions are also measured using these tools. RAROC and/or economic profit are significant components of line incentive compensation programs and senior management incentive plans. Changes in Methodology We continuously update segment information for changes that occur in the management of
Economic profit is a measure of the earnings above an explicit charge for the capital used to support a transaction or business line. It is calculated as a dollar amount of return. RAROC is a ratio of return to risk and is stated as a percentage. The return component of both of these measures is economic net income, which reflects two adjustments to segment earnings. First, we replace current period provision expense with expected losses (a statistically derived, forward-looking number that represents the average expected loan losses over time), and we remove certain noncash expenses. The risk component for these measures is economic capital, which is discussed below, as is the capital charge used in calculating economic profit. Economic Capital A disciplined and consistent approach to quantifying risk is required to achieve an accurate risk-based pricing and value-based performance reporting system. We employ an economic capital framework developed to measure the declines in economic value that a transaction, portfolio or business unit could incur given an extreme event or business environment. The greater the frequency and severity of potential negative outcomes, the greater the levels of capital required. The five types of risk to which we attribute economic capital are: Credit Risk: Credit risk, which represented 56 percent of our economic capital in 2006, is the risk of loss due to adverse changes in a borrower’s ability to meet its financial obligations under agreed-upon terms.
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Wachovia Corporation 2006 Annual Report
our businesses. For example, in 2006, we moved deposit balances relating to certain brokerage sweep accounts originated in the General Bank to Capital Management, which resulted in these brokerage sweep accounts being included in Capital Management’s results consistent with how they are managed. In addition, we transferred certain customer relationships and investment advisors to Wealth Management from Capital Management relating to a new investment management platform in Wealth Management. While these changes are not significant to the results of operations of our segments, we have updated the information for 2005 and 2004 to reflect these and other changes. The impact to segment earnings as a result of these changes was: A $115 million decrease in the General Bank in 2005 and a $43 million decrease in 2004. An $8 million decrease in Wealth Management in 2005 and a $6 million decrease in 2004. A $4 million decrease in the Corporate and Investment Bank in 2005 and no change in 2004. A $116 million increase in Capital Management in 2005 and a $4 million decrease in 2004. An $11 million increase in the Parent in 2005 and a $53 million increase in 2004. In January 2007, we moved cross-border leasing activity from the Corporate and Investment Bank to the Parent. Our current and historical financial reporting in 2007 will reflect this change. Accordingly, Corporate and Investment Bank segment earnings of $81 million and $106 million in 2006 and 2005, respectively, and the related average loans, net of $6.0 billion and $6.3 billion, respectively, will be included in the Parent prior period information beginning in 2007. General Bank The General Bank includes our Retail and Small Business and Commercial lines of business. The General Bank’s products by business line include: Retail Bank: Checking, savings and money market accounts; time deposits and IRAs; home equity, residential mortgage, student and personal loans; debit and credit cards; mutual funds and annuities. Small Business: Deposit, loan and investment products and services to businesses with annual revenues up to $3 million. Commercial Banking: Commercial deposit, lending, treasury management, dealer financial services and commercial real estate solutions to businesses typically with annual revenues between $3 million and $250 million.
General Bank
Performance Summary Years Ended December 31,
(Dollars in millions)
2006 $ 11,922 3,580 198 15,700 428 7,117 2,976 $ $ $ 5,179 4,008 54.61% 9,191 45.33% $139,940 223,445 $232,720 55,622
2005 9,486 2,878 194 12,558 277 6,296 2,196 3,789 2,872 51.87 7,027 50.13 111,202 163,411 201,711 42,022
2004 7,888 2,434 157 10,479 314 5,453 1,711 3,001 2,278 52.42 5,499 52.04 93,608 128,056 165,721 43,206
Income statement data Net interest income (Tax-equivalent) Fee and other income Intersegment revenue Total revenue (Tax-equivalent) Provision for credit losses Noninterest expense Income taxes (Tax-equivalent) Segment earnings Performance and other data Economic profit Risk adjusted return on capital (RAROC) Economic capital, average Cash overhead efficiency ratio
(Tax-equivalent)
Lending commitments Average loans, net Average core deposits FTE employees
The General Bank’s earnings rose 37 percent to $5.2 billion, reflecting the addition of Golden West for three months and Westcorp for 10 months, as well as organic growth. Key General Bank trends in 2006 compared with 2005 included: 25 percent revenue growth, led by 26 percent growth in net interest income related to a larger balance sheet. Organic strength in loan production, particularly in commercial, also contributed to net interest income growth. Golden West contributed $938 million and Westcorp contributed $903 million to net interest income. 24 percent growth in fee and other income included growth in service charges and strong debit card interchange income, as well as the $100 million MBNA termination fee. In addition, a larger mortgage servicing portfolio and higher mortgage originations contributed to growth. Commercial loan growth was driven by commercial real estate and middle-market commercial. Consumer loan growth included the impact of the October 2006 addition of $124.0 billion from Golden West, principally variable rate consumer real estate-secured loans; and the impact of the March 2006 addition of $13.5 billion from Westcorp, with additional organic growth in mortgages and home equity loans. Higher interest spreads in the Westcorp portfolio partially offset slowing growth in home equity lines as customers shifted from variable rate to fixed rate products. Deposit growth was led by consumer certificates of deposit and money market funds. Net new retail checking accounts increased 555,000 in 2006, compared with an increase of 535,000 in 2005.
Wachovia Corporation 2006 Annual Report
23
Management’s Discussion and Analysis
13 percent growth in noninterest expense included higher personnel costs related to the impact of Golden West and Westcorp, as well as increased revenue-based incentive compensation, hiring and employee stock incentive compensation, de novo branch activity and branch consolidations, and costs related to reentering the credit card business. Continued improvement in the overhead efficiency ratio to 45.33 percent, due to merger efficiencies, expense management efforts and revenue growth. Wealth Management
Performance Summary Years Ended December 31,
(Dollars in millions)
6 percent revenue growth driven by 8 percent growth in fee and other income and a 4 percent increase in net interest income. Fee and other income growth reflected increased commissions due to the May 2005 acquisition of Palmer & Cay, a commercial insurance brokerage firm, and modest growth in trust and investment management fees. Net interest income growth driven by a 16 percent increase in average loans, largely in commercial accounts and consumer mortgages, and a 7 percent increase in average core deposits. 6 percent growth in noninterest expense, including costs related to the transition to a new investment management platform, the impact of Palmer & Cay, and increased employee stock compensation expense. 10 percent growth in assets under management from year-end 2005 to $72.4 billion at year-end 2006. Corporate and Investment Bank
Performance Summary Years Ended December 31,
(Dollars in millions)
2006 $ 602 779 6 1,387 2 964 154 $ $ $ 267 196 48.07% 528 69.51% $ 6,504 16,205 $ 14,493 4,411
2005 581 718 6 1,305 6 908 143 248 184 48.89 486 69.56 5,840 13,916 13,605 4,739
2004 497 593 5 1,095 (1) 781 115 200 131 39.41 460 71.36 4,711 11,055 11,964 3,890
Income statement data Net interest income (Tax-equivalent) Fee and other income Intersegment revenue Total revenue (Tax-equivalent) Provision for credit losses Noninterest expense Income taxes (Tax-equivalent) Segment earnings Performance and other data Economic profit Risk adjusted return on capital (RAROC) Economic capital, average Cash overhead efficiency ratio (Tax-equivalent) Lending commitments Average loans, net Average core deposits FTE employees
2006 $ 2,037 4,799 (179) 6,657 (32) 3,547 1,160 $ $ $ 1,982 1,141 28.73% 6,436 53.28% $107,155 44,906 $ 26,231 5,711
2005 2,220 3,696 (169) 5,747 (27) 3,037 1,018 1,719 1,005 29.48 5,438 52.85 103,079 38,754 23,607 5,789
2004 2,387 2,924 (128) 5,183 (41) 2,579 974 1,671 1,042 33.64 4,604 49.77 81,461 31,681 18,325 4,723
Income statement data Net interest income (Tax-equivalent) Fee and other income Intersegment revenue Total revenue (Tax-equivalent) Provision for credit losses Noninterest expense Income taxes (Tax-equivalent) Segment earnings Performance and other data Economic profit Risk adjusted return on capital (RAROC) Economic capital, average Cash overhead efficiency ratio
(Tax-equivalent)
Wealth Management Wealth Management includes private banking, personal trust, investment advisory services, financial planning and insurance brokerage. Products and services include: Private Banking: Customized deposit, credit and debt structuring services, including professional practice lending, insurance premium, marine and aircraft financing. Trust and Investment Management: Legacy management such as personal trust, estate settlement and charitable services; investment management products and services including independent manager search and selection; family office services and administration. Insurance: Risk management services encompassing property and casualty, group health and benefit, and life insurance. Wealth Management’s earnings increased by 8 percent to $267 million in 2006. Key Wealth Management trends in 2006 compared with 2005 included:
Lending commitments Average loans, net Average core deposits FTE employees
Corporate and Investment Bank Our Corporate and Investment Bank includes the following lines of business: Corporate Lending: Large corporate lending and commercial leasing. Investment Banking: Equities, merger and acquisition advisory services, the activities of our fixed income division (including interest rate products, leveraged finance, high grade, structured products and non-dollar products), and principal investing (which encompasses
24
Wachovia Corporation 2006 Annual Report
direct investments primarily in private equity and mezzanine securities, and investments in funds sponsored by select private equity and venture capital groups). Treasury and International Trade Finance: Treasury management products and services, domestic and international correspondent banking operations, and international trade services. Our Corporate and Investment Bank increased earnings 15 percent to $2.0 billion, reflecting strong investment banking results, primarily real estate capital markets and corporate client origination activity, as well as higher principal investing results. Key Corporate and Investment Bank trends in 2006 compared with 2005 included: 16 percent revenue growth driven by a 30 percent increase in fee and other income offsetting an 8 percent decline in net interest income. Net interest income declined as solid loan and deposit growth was offset by spread compression in asset-based lending, runoff in higher spread leasing assets and a decline in trading-related interest income that was offset in trading profits. The growth in fee income reflected strong investment banking results, including strength in advisory and underwriting activities; strong structured products results driven by commercial mortgage securitization activity; the impact of the fourth quarter 2005 acquisitions of AmNet Mortgage, Inc., a nationwide residential mortgage broker, and Union Bank of California’s (UBOC) international correspondent banking business; and the previously mentioned principal investing gains and higher trading account profits, which were partially offset by lower tradingrelated net interest income. In 2005, fee income included a gain of $122 million from the sale of equity securities received in settlement of loans. A total contribution from principal investing of $538 million in 2006 compared with $406 million in 2005. This included a $116 million unrealized gain in 2006 in our fund portfolio recognized on the portion we retained following the sale of a minority interest in an entity holding certain of our fund investments. Additionally, realized gains on the fund portfolio were higher in 2006 compared with 2005. The direct portfolio realized gains of $195 million, down $36 million from 2005. A 17 percent increase in noninterest expense due primarily to higher revenue-based incentive compensation; investment in both revenue and efficiency projects; the impact of acquisitions, including AmNet and UBOC’s international correspondent banking business; and increased employee stock compensation expense.
Strong core deposit growth of 11 percent primarily from higher commercial mortgage servicing and international correspondent banking, and 16 percent higher loans primarily reflecting increased corporate loans and the international correspondent banking business acquisition. In commercial mortgage servicing, we service commercial mortgages and commercial mortgage-backed securities and hold the related escrow and other deposits. Capital Management
Performance Summary Years Ended December 31,
(Dollars in millions)
2006 $ 1,013 5,041 (32) 6,022 – 4,555 536 $ $ $ 931 757 58.84% 1,582 75.65% $ 219 711 $ 31,393 17,556
2005 834 4,591 (34) 5,391 – 4,293 403 695 531 46.52 1,494 79.64 208 357 34,659 17,364
2004 564 4,703 (34) 5,233 – 4,484 272 477 328 35.30 1,352 85.69 119 290 31,729 18,913
Income statement data Net interest income (Tax-equivalent) Fee and other income Intersegment revenue Total revenue (Tax-equivalent) Provision for credit losses Noninterest expense Income taxes (Tax-equivalent) Segment earnings Performance and other data Economic profit Risk adjusted return on capital (RAROC) Economic capital, average Cash overhead efficiency ratio
(Tax-equivalent)
Lending commitments Average loans, net Average core deposits FTE employees
Capital Management Capital Management includes Retail Brokerage Services, which encompasses retail brokerage and our annuity and reinsurance businesses, and Asset Management, which includes mutual funds, customized advisory services and defined benefit and defined contribution retirement services. Capital Management provides a full line of investment products and financial and retirement services including: Retail Brokerage Services: Stocks, bonds, mutual funds, fixed and variable annuities, reinsurance, asset management accounts, and other investment products and services. Asset Management: Mutual funds, customized advisory services and defined benefit and defined contribution retirement services. Capital Management grew earnings 34 percent to $931 million, reflecting growth in retail brokerage managed account fees as well as higher net interest income as deposit spreads improved. Key Capital Management trends in 2006 compared with 2005 included: 12 percent revenue growth driven by strength in retail brokerage managed account fees as managed assets grew 26 percent to $133.7 billion. Momentum in building
Wachovia Corporation 2006 Annual Report
25
Management’s Discussion and Analysis
recurring revenue streams continued as this growth reflected strong client demand for managed accounts. Net interest income rose 21 percent as a result of improved deposit spreads. $5.1 billion in revenue from our retail brokerage businesses included transactional revenues of $1.9 billion and recurring and other income of $3.2 billion. $957 million in revenue from our asset management businesses, an increase of $93 million reflecting the June 2006 acquisitions of the Ameriprise 401(k) record-keeping business and Metropolitan West Capital Management, and Golden West, as well as core growth in assets under management. 6 percent growth in noninterest expense, primarily due to increased commissions and other incentives, acquisition impact, and employee stock compensation expense. Mutual Funds
Years Ended December 31,
(In billions)
31, 2006, and included the addition of $23.0 billion in certain mutual fund assets not previously included as a component of client assets. This increase was offset by a decline in client assets of $29.9 billion due to the loss of assets from a clearing client that was acquired by another firm. Parent
Performance Summary Years Ended December 31,
(Dollars in millions)
2006 $ (170) 346 7 183 36 1,114 412 (880) $ $ $ (499) (541) (8.49)% 2,770 374.90 % $ $ 597 22,455 4,189 24,938
2005 779 336 3 1,118 (7) 1,021 367 (408) 145 55 12.98 2,848 54.08 508 11,484 5,139 24,066
2004 875 125 – 1,000 (15) 925 297 (275) 68 35 12.52 2,324 49.23 408 951 3,869 25,298
Income statement data Net interest income (Tax-equivalent) Fee and other income Intersegment revenue Total revenue (Tax-equivalent) Provision for credit losses Noninterest expense Minority interest Income taxes (Tax-equivalent) Segment earnings (loss) Performance and other data Economic profit Risk adjusted return on capital (RAROC) Economic capital, average Cash overhead efficiency ratio
(Tax-equivalent)
2006 Amount Mix $ 36 23 49 33% 21 46
2005 Amount Mix $ 32 23 37 $ 35% 25 40
2004 Amount Mix $ 29 26 37 $ 31% 29 40
Assets under management Equity Fixed income Money market Total mutual fund assets
Lending commitments Average loans, net Average core deposits FTE employees
$ 108 100%
92 100%
92 100%
Assets Under Management and Securities Lending
Years Ended December 31,
(In billions)
2006 Amount Mix $ 101 114 61 37% 41 22
2005 Amount Mix $ 82 105 43 35% 46 19
2004 Amount Mix $ 81 104 44 35% 46 19
Assets under management Equity Fixed income Money market Total assets under management Securities lending Total assets under management and securities lending
$ 276 100% 57 –
$ 230 100% 57 –
$ 229 100% 41 –-
Parent Parent includes all asset and liability management functions, including managing our securities portfolio for liquidity and interest rate risk. Parent also includes goodwill and other intangible assets, and related funding costs, certain revenues and expenses that are not allocated to the business segments; and the results of wind-down or divested businesses, including our HomEq Servicing business, which was divested on November 1, 2006; and the Corporate and Institutional Trust businesses that were divested in December 2005. Key trends in the Parent segment in 2006 compared with 2005 included: Lower net interest income, reflecting reduced spreads on funding the securities portfolio and growth in wholesale borrowings due to the addition of Westcorp, partially offset by growth in the securities portfolio. In addition, the contribution from hedge-related derivatives was lower. A $10 million increase in fee and other income reflecting a $115 million increase related to fourth quarter 2006 adjustments to record certain fees when earned rather than when billed and for certain discontinued hedging relationships, partially offset by a $110 million decrease due to the divested trust businesses.
$ 333
–
$ 287
–
$ 270
–-
Total assets under management increased 20 percent from 2005 to $276.0 billion at December 31, 2006, including a $17.8 billion addition of assets retained from $24.0 billion transferred to the Parent in the fourth quarter of 2005 in connection with the divestiture of our Corporate and Institutional Trust businesses. In addition, assets under management increased $5.5 billion from Metropolitan West Capital Management and $3.2 billion from Golden West. Total net inflows in assets under management were $9.0 billion in 2006, while net asset appreciation was $10.8 billion. Equity assets reached $100.8 billion, up 22 percent from year-end 2005. Total brokerage client assets grew 11 percent from year-end 2005 to $760.0 billion at December
26
Wachovia Corporation 2006 Annual Report
Net securities gains of $75 million compared with losses of $3 million in the year-ago period. A 9 percent increase in noninterest expense reflecting fourth quarter 2006 accounting adjustments for additional accruals for employee paid time off and for certain other sundry expenses. This segment reflects the impact of Prudential Financial’s 38 percent minority interest in Wachovia Securities Financial Holdings, LLC. Total minority interest expense, which also includes other subsidiaries, was $412 million in 2006 compared with $367 million in 2005.
Securities Available for Sale
Years Ended December 31,
(In billions)
2006 $ $ $
(a)
2005 113.7 (0.5) 0.9 5.1 0.1 5.2
2004 109.6 1.8 0.9 5.2 – 5.2
Market value Net unrealized gain (loss) Memoranda (Market value) Residual interests Retained bonds Investment grade Other Total
(a)
108.6 (1.0) 0.8 6.6 –
$
6.6
$6.1 billion had credit ratings of AA and above at December 31, 2006.
Loans - On-Balance Sheet
Years Ended December 31,
(In millions)
Balance Sheet Analysis
Earning Assets Our primary types of earning assets are securities and loans. The increase in earning assets from $451.8 billion at year-end 2005 to $614.5 billion at year-end 2006 largely reflected the impact of acquisitions. Average earning assets in 2006 were $494.1 billion, which represented a 15 percent increase from 2005, primarily from Golden West and Westcorp. Securities The securities portfolio, all of which is classified as available for sale, consists primarily of high quality, mortgage- and asset-backed securities, principally obligations of U.S. Government agencies and sponsored entities. We use this portfolio primarily to manage liquidity, interest rate risk and regulatory capital, and to take advantage of market conditions that create more economically attractive returns on these investments. The decrease in securities available for sale from December 31, 2005, reflects the sale of securities at the end of the third quarter of 2006 to achieve our desired asset/liability profile in preparation for our merger with Golden West. Unrealized net securities losses in 2006 increased $455 million due to the effect of higher rates primarily on our fixed rate mortgage-backed securities. The average duration of this portfolio increased to 3.4 years from 3.3 years due to the extension of mortgage-backed securities in the higher rate environment. We retain interests in the form of either bonds or residual interests in connection with certain securitizations. The retained interests result primarily from the securitization of residential mortgage loans, home equity lines, auto loans and student loans. Included in securities available for sale at December 31, 2006, were residual interests with a market value of $816 million, which included a net unrealized gain of $251 million, and retained bonds from securitizations with a market value of $6.6 billion, which included a net unrealized loss of $15 million. The average rate earned on securities available for sale was 5.38 percent in 2006 and 5.14 percent in 2005. The Interest Rate Risk Management section further explains our interest rate risk management practices.
Commercial Commercial, financial and agricultural Real estate - construction and other Real estate - mortgage Lease financing Foreign Total commercial Consumer Real estate secured Student loans Installment loans Total consumer Total loans Unearned income Loans, net (On-balance sheet)
2006 $ 96,285 16,182 20,026 25,341 13,464 171,298 225,826 7,768 22,660 256,254 427,552 7,394 $420,158
2005 87,327 13,972 19,966 25,368 10,221 156,854 94,748 9,922 6,751 111,421 268,275 9,260 259,015
2004 75,095 12,673 20,742 25,000 7,716 141,226 74,161 10,468 7,684 92,313 233,539 9,699 223,840
Loans - Managed Portfolio (Including on-balance sheet)
Years Ended December 31,
(In millions)
2006 $180,358 241,297 10,948 26,355 $458,958
2005 161,941 110,299 11,974 10,598 294,812
2004 145,072 97,021 11,059 10,359 263,511
Commercial Real estate secured Student loans Installment loans Total managed portfolio
Loans We have taken several steps to enhance loan growth through acquisitions and investments that we expect will strengthen our loan portfolio mix with a greater proportion of consumer loans, including auto loans through our expanded dealer financial services network, direct issuance of credit cards, and by offering a broader suite of mortgage loan products through our bank branch network and World Savings Bank offices. In commercial lending, we have pursued risk reduction strategies in recent years to actively reduce potential problem loans and certain large corporate loans. We will continue to actively monitor loan quality and take proactive steps to reduce risk when warranted. The 62 percent increase in net loans from year-end 2005 included the addition of $124.0 billion in loans related to Golden West and the addition of $13.5 billion in largely
Wachovia Corporation 2006 Annual Report
27
Management’s Discussion and Analysis
Year-End 2006 Commercial and Industrial Loans and Leases
Industry Classification
(In millions)
Outstanding $ 1,426 1,147 1,216 1,544 712 980 844 5,059 12,928 19,928 16,963 14,689 9,591 8,082 1,423 1,985 6,989 3,751 2,951 652 2,005 1,390 843 21,719 $ 125,889
Committed Exposure (a) 4,228 3,418 3,341 3,139 3,114 2,421 2,022 18,892 40,575 46,510 44,422 22,679 20,161 15,738 13,919 13,185 10,225 8,861 8,371 8,331 5,963 3,492 1,385 21,747 285,564
Manufacturing Consumer products Steel and metal products Food and beverage Publishing and printing Chemicals Construction and construction materials Electronics All other manufacturing Total manufacturing Financial services Services Retail trade Property management Wholesale trade Public utilities Public administration Individuals Insurance Building contractors Transportation Mining Telecommunications and cable Agriculture, forestry and fishing All other (b) Total
auto loans related to Westcorp. Nine percent growth in commercial loans reflected strength in middle-market lending, commercial real estate construction, large corporate lending and international lending, partially offset by declines in our leasing portfolio. In addition to the acquisitions, growth in consumer loans from year-end 2005 reflected increased consumer real estate-secured activity in our financial centers. Our loan portfolio is broadly diversified by industry, concentration and geography. Additionally, the portfolio is well collateralized: Commercial loans represented 40 percent and consumer loans 60 percent of the loan portfolio at December 31, 2006. 79 percent of the commercial loan portfolio is secured by collateral. 99 percent of the consumer loan portfolio is secured by collateral or guaranteed. Of our $225.8 billion consumer real estate-secured loan portfolio: 87 percent is secured by a first lien. 83 percent has a loan-to-value ratio of 80 percent or less. 95 percent has a loan-to-value ratio of 90 percent or less. Our managed loan portfolio grew 56 percent from year-end 2005, reflecting the growth discussed above. In addition, beginning in 2006, commercial mortgage warehouse activity is reflected in loans held for sale. The managed loan portfolio includes the on-balance sheet loan portfolio; loans held for sale, loans securitized for which the retained interests are classified in securities; and the off-balance sheet portfolio of securitized loans sold where we service the loans. Nonperforming Assets Nonperforming assets increased from year-end 2005 to 0.32 percent of loans, foreclosed properties and loans held for sale. Nonaccrual loans nearly doubled from year-end 2005, primarily driven by the addition of $700 million associated with Golden West. New inflows to commercial nonaccrual loans in 2006 were $621 million compared with new inflows of $751 million in 2005. Impaired commercial loans were $319 million at December 31, 2006, and $392 million at December 31, 2005. Past Due Loans Accruing loans 90 days or more past due, excluding loans that are classified as loans held for sale, were $650 million at December 31, 2006, compared with $625 million at December 31, 2005. Of the total past due loans, $52 million were commercial loans or commercial real estate loans and $598 million were consumer loans.
(a) Committed exposure includes amounts outstanding and unfunded lending commitments and letters of credit. It does not include risk mitigating credit swap derivatives. (b) Leases included in “All other.”
Year-End 2006 Commercial Real Estate Loans
Project Type Classification
(In millions)
Outstanding $ 4,071 5,654 5,477 4,151 4,578 2,752 2,494 2,173 1,050 3,808 $ 36,208
Committed Exposure (a) 7,787 7,341 7,182 6,610 6,204 5,124 2,996 2,625 1,254 4,377 51,500
Single family Office buildings Retail Land-improved Apartments Condominiums Industrial Land-unimproved Lodging Other Total Distribution by Facility Size (Percent) Less than $10 million $10 million to $25 million $25 million to $50 million All other Total
(a) Committed exposure includes amount outstanding.
42 % 26 20 12 100 %
37 27 24 12 100
28
Wachovia Corporation 2006 Annual Report
Net Charge-offs Net charge-offs as a percentage of average net loans of 0.12 percent in 2006 were up slightly from 2005. In 2006, commercial net charge-offs were $24 million compared with $36 million in 2005. Consumer net chargeoffs were $342 million, up from $171 million in 2005, largely reflecting Westcorp. The low level of net charge-offs reflects a continuing robust credit environment and the highly collateralized nature of our portfolio, and our careful management of the inherent credit risk in our loan portfolio. Golden West has a long record of extremely low net charge-offs, including none for the past eight years, reflecting their strong underwriting and credit risk management. Accordingly, the addition of Golden West also reduced our annual charge-off percentage. Provision for Credit Losses Provision expense rose 74 percent to $434 million, largely reflecting the effect of Westcorp and $38 million related to our new credit card portfolio. More information on the provision for credit losses, including the impact of transfers to loans held for sale, is in Table 10: Allowance for Loan Losses and Nonperforming Assets. Allowance for Loan Losses and Reserve for Unfunded Lending Commitments The allowance for loan losses increased $636 million from year-end 2005 to $3.4 billion at December 31, 2006, including $303 million from Golden West. The unallocated portion of the allowance increased from year-end 2005 by $25 million primarily reflecting the addition of the Golden West portfolio, partially offset by a reduction from updated analyses of exposures to the 2005 hurricanes. The reserve for unfunded lending commitments was $154 million at December 31, 2006, and $158 million at December 31, 2005. The reserve for unfunded lending commitments relates to commercial lending activity and is included in other liabilities. Further information is in applicable Notes to Consolidated Financial Statements. Information on the methodology we use in maintaining these balances is in the Critical Accounting Policies section. Loans Held for Sale Loans held for sale include loans originated for sale or securitization as part of our core business strategy and the activities related to our ongoing portfolio risk management strategies to reduce exposure to areas of perceived higher risk. At December 31, 2006, and at year-end 2005, core business activity, which includes residential and commercial mortgages and auto loans that we originate with the intent to sell to third parties, represented substantially all loans held for sale. In 2006, we sold or securitized $54.8 billion in loans out of the loans held for sale portfolio, including $27.0 billion of commercial loans and $27.8 billion of consumer loans. Of these loans, $3 million were nonperforming. In 2005, we sold or securitized $32.8 billion of loans out of the loans
Asset Quality
Years Ended December 31,
(In millions)
2006 $ 420,158 $ 3,360 0.80 % 272 246% $ 366 0.12 % $ 1,234 132 16 $ 1,382
2005 259,015 2,724 1.05 439 378 207 0.09 620 100 32 752
2004 223,840 2,757 1.23 289 251 300 0.17 955 145 157 1,257
Loans, net Allowance for loan losses Allowance as % of loans, net Allowance as % of nonaccrual and restructured loans Allowance as % of nonperforming assets Net charge-offs Net charge-offs as % of average loans, net Nonperforming assets Nonaccrual loans Foreclosed properties Loans held for sale Total nonperforming assets Nonperforming assets to loans, net, foreclosed properties and loans held for sale
0.32 %
0.28
0.53
Year-End 2006 Nonaccrual Commercial and Industrial Loans and Leases
Industry Classification
(In millions)
Outstanding $ 62 43 27 21 20 15 4 34 $ 226
Services Manufacturing Retail and wholesale trade Property management Telecommunications Building contractors Finance All other Total
held for sale portfolio, including $12.6 billion of commercial loans and $20.2 billion of consumer loans, primarily residential mortgages. Of these loans, $56 million were nonperforming. We also transferred $1.2 billion of auto loans to loans held for sale in connection with securitization activity in 2005. Goodwill In connection with acquisitions, we record purchase accounting adjustments to reflect the respective fair values of the assets and liabilities of acquired entities, as well as certain exit costs related to these mergers. Purchase accounting adjustments are preliminary and are subject to refinement for up to one year following consummation. We recorded preliminary fair value and exit cost purchase accounting adjustments amounting to a net increase in goodwill of $905 million ($572 million after tax) related to Golden West. In addition, we recorded a deposit base intangible amounting to $409 million ($261 million after tax). Based on a purchase price of $24.3 billion and Golden West tangible stockholders’ equity of $9.7 billion, this resulted in goodwill of $14.9 billion at December 31, 2006.
Wachovia Corporation 2006 Annual Report
29
Management’s Discussion and Analysis
We recorded preliminary fair value and exit cost purchase accounting adjustments amounting to a net decrease in goodwill of $341 million ($210 million after tax) related to Westcorp. In addition, we recorded dealer relationship and deposit base intangibles amounting to $405 million ($253 million after tax). Based on a purchase price of $3.8 billion and Westcorp tangible stockholders’ equity of $1.9 billion, this resulted in goodwill of $1.5 billion at December 31, 2006. Further information on business combinations is in applicable Notes to Consolidated Financial Statements.
exclude consumer certificates of deposit, increased 2 percent to $244.2 billion. Average consumer certificates of deposit rose $25.2 billion from 2005. The ratio of average noninterest-bearing deposits to average core deposits was 21 percent in 2006 and 22 percent in 2005. The portion of core deposits in higher rate, other consumer time deposits was 31 percent at December 31, 2006, and 15 percent at December 31, 2005, with the increase largely reflecting the impact of the October 2006 addition of $54.9 billion in certificates of deposit from Golden West. Other consumer time and other noncore deposits usually pay higher rates than savings and transaction accounts, but they generally are not available for immediate withdrawal. They are also less expensive to service. Purchased Funds Average purchased funds, which include wholesale borrowings with maturities of 12 months or less, were $93.9 billion in 2006, including the impact of the October 2006 addition of $4.5 billion from Golden West, and $98.7 billion in 2005. Purchased funds were $84.8 billion at December 31, 2006, compared with $93.3 billion at December 31, 2005, as higher foreign deposits were partially offset by the effect of greater use of long-term debt for funding rather than short-term borrowings. Long-term Debt Long-term debt (defined as an original maturity greater than 12 months) was $138.6 billion at December 31, 2006, and $49.0 billion at December 31, 2005, reflecting the addition of $48.1 billion of Golden West debt, $13.0 billion of Westcorp debt, the issuance of $38.3 billion of debt including the multi-currency and WITS hybrid securities noted below, and $4.1 billion of on-balance sheet securitizations. In 2007, scheduled maturities of longterm debt amount to $31.1 billion. We anticipate replacing the maturing obligations. In July 2006, Wachovia and Wachovia Bank, National Association established a $20.0 billion Euro Medium Term Note Programme (EMTN), under which we may issue senior and subordinated debt securities. These securities are not registered with the Securities and Exchange Commission and may not be offered in the United States without applicable exemptions from registration. Under EMTN, Wachovia and Wachovia Bank issued an aggregate $9.7 billion of debt securities in 2006 and had up to $10.3 billion available for issuance at December 31, 2006. The WITS transaction included a junior subordinated note and a forward contract for the sale of noncumulative perpetual preferred stock to a trust. The trust then issued $2.5 billion of securities to investors. The junior subordinated note qualifies as tier 1 capital. Under our current shelf registration statement filed with the SEC at December 31, 2006, we had $14.0 billion of senior or subordinated debt securities, common stock or preferred
Liquidity and Capital Adequacy
Liquidity planning and management are necessary to ensure we maintain the ability to fund operating costs effectively and to meet current and future obligations such as loan commitments and deposit outflows. Funding sources primarily include customer-based core deposits but also include purchased funds, maturing assets and other cash flows from operations. Wachovia is one of the nation’s largest core deposit-funded banking institutions. Our large deposit base, which now stretches from Connecticut to Florida and west to Texas and California, creates considerable funding diversity and stability. In addition to core deposits, wholesale funding sources provide a broad and diverse supplemental source of funds on both a secured and unsecured basis. Typically wholesale funding can be obtained for a broader range of maturities than core deposits, which adds flexibility in liquidity planning and management. We manage our balance sheet in a manner we believe will provide adequate liquidity in a variety of underlying circumstances, ranging from current conditions to multiple, progressively more adverse situations. We estimate funding requirements and funding sources appropriate to each scenario and make current balance sheet adjustments if needed to maintain positive estimated liquidity in all identified circumstances. The Liquidity Risk Management section has more information. Our senior and subordinated debt securities and commercial paper are highly rated by the major debt rating agencies, which reduces our funding costs. A table inside the back cover shows the current ratings. As noted below, we remained “well capitalized” for regulatory purposes at December 31, 2006. Core Deposits Core deposits, which include savings, interest-bearing checking accounts, noninterest-bearing and other consumer time deposits, and deposits held in certain brokerage sweep accounts, increased from year-end 2005 to $371.8 billion at December 31, 2006. Compared with 2005, average core deposits in 2006, which included the impact of the October 2006 addition of $67.0 billion from Golden West and the impact of the March 2006 addition of $2.2 billion from Westcorp, increased 11 percent to $309.0 billion and average low-cost core deposits, which
30
Wachovia Corporation 2006 Annual Report
stock available for issuance under this program. In addition at December 31, 2006, we had available for issuance up to $4.5 billion under a medium-term note program covering senior or subordinated debt securities. Also, at December 31, 2006, Wachovia Bank had a global note program for the issuance of up to $21.1 billion of senior and subordinated notes. In 2006, we issued $14.8 billion of senior and subordinated bank notes under this program. In February 2007, we issued $875 million in hybrid trust preferred securities that qualify as tier 1 capital under a trust preferred shelf registration. The issuance of debt or equity securities continues under all our programs and depends on future market conditions, funding needs and other factors. Credit Lines Wachovia Bank has a $1.9 billion committed back-up line of credit that expires in 2010. This credit facility contains a covenant that requires us to maintain a minimum level of adjusted total equity capital. We have not used this line of credit. A nonbank subsidiary has a $2.0 billion committed backup line of credit that expires in 2011. This credit facility has no financial covenants associated with it. In connection with initiating this line, we borrowed $250 million in September 2006, and repaid this amount in October 2006. Dividend and Share Activity
Years Ended December 31,
(In millions, except per share data)
which is discussed further in applicable Notes to Consolidated Financial Statements. Accordingly, we recorded a cumulative effect adjustment to January 1, 2006, retained earnings of $41 million after tax. We also adopted SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, (SFAS 158), effective December 31, 2006, which is discussed further in applicable Notes to Consolidated Financial Statements. Accordingly, we recorded a $1.1 billion after-tax reduction to accumulated other comprehensive income on December 31, 2006. This reduction to accumulated other comprehensive income represents the net effect of certain pension and postretirement amounts previously deferred and recorded on the balance sheet in other assets and liabilities and regularly disclosed in the related Notes to Consolidated Financial Statements. The adoption of FSP 13-2 and FIN 48 on January 1, 2007, resulted in a $1.4 billion after-tax reduction to beginning retained earnings on that date. Subsidiary Dividends Wachovia Bank is the largest source of subsidiary dividends paid to the parent company. Capital requirements established by regulators limit dividends that this subsidiary and certain other of our subsidiaries can pay. Under these and other limitations, which include an internal requirement to maintain all deposit-taking banks at the well capitalized level, at December 31, 2006, our subsidiaries had $7.9 billion available for dividends that could be paid without prior regulatory approval. Our subsidiaries paid $4.3 billion in dividends to the parent company in 2006. Regulatory Capital Our capital ratios were above regulatory minimums in 2006 and we continued to be classified as well capitalized. The tier 1 capital ratio decreased 8 basis points from December 31, 2005, to 7.42 percent at December 31, 2006, driven primarily by the impact of the cash payment associated with the Golden West acquisition and by additional risk-weighted assets, offset by the issuance of securities noted above and a benefit resulting from the purchase of credit protection from a securitization trust on a portion of $9.8 billion of consumer real estate-secured loans. Our total capital ratio was 11.33 percent and our leverage ratio was 6.01 percent at December 31, 2006, and 10.82 percent and 6.12 percent, respectively, at December 31, 2005. Banking regulators have issued an interim rule under which the reduction of stockholders’ equity associated with SFAS 158 is not reflected in the determination of regulatory capital. Accordingly, the adoption of SFAS 158 does not at this time have an effect on our regulatory capital. Information regarding our pension and other postretirement plans is included in applicable Notes to Consolidated Financial Statements. However, adoption of FSP 13-2 and FIN 48 have not been similarly treated by banking regulators and therefore our regulatory capital was reduced on January 1, 2007. More information is in the Executive Summary.
2006 $ 3,589 $ 2.14 82 1,681
2005 3,039 1.94 52 1,585
2004 2,306 1.66 47 1,370
Dividends on common stock Dividends per common share Common shares repurchased Average diluted common shares outstanding
Stockholders’ Equity The management of capital in a regulated banking environment requires a balance between optimizing leverage and return on equity while maintaining sufficient capital levels and related ratios to satisfy regulatory requirements. Our goal is to generate attractive returns on equity to stockholders while maintaining sufficient regulatory capital ratios. Stockholders’ equity increased 47 percent from year-end 2005, to $69.7 billion at December 31, 2006, including $18.5 billion related to the purchase of Golden West and $3.8 billion related to the purchase of Westcorp; repurchases of 82 million common shares at a cost of $4.5 billion in connection with our share repurchase programs; and net depreciation in the securities portfolio. The higher level of share repurchases in 2006 compared with 2005 reflected opportunistic deployment of excess capital partially related to higher earnings. At December 31, 2006, we were authorized to buy back 42 million shares of common stock. Our 2006 Form 10-K has additional information related to share repurchases. We adopted SFAS No. 156, Accounting for Servicing of Financial Assets, (SFAS 156), effective January 1, 2006,
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31
Management’s Discussion and Analysis
Off-Balance Sheet Transactions
In the normal course of business, we engage in a variety of financial transactions that under GAAP either are not recorded on the balance sheet or are in amounts that differ from the full contract or notional amounts. These transactions involve varying elements of market, credit and liquidity risk. The following discussion also includes retained interests from securitization transactions. Summary of Off-Balance Sheet Exposures
(In millions)
December 31, 2006 Carrying Amount Exposure $ – 115 9 50 – $ 174 61,715 37,783 27,610 7,543 1,131 135,782
Undrawn standby letters of credit amounted to $37.8 billion at December 31, 2006, and $35.6 billion at December 31, 2005. For letters of credit, we typically charge a fee equal to a percentage of the unfunded commitment. We recognized fee income on unfunded letters of credit of $266 million in 2006 and $251 million in 2005. The risk associated with standby letters of credit is incorporated in the overall assessment of our liquidity risk as described in the Liquidity Risk Management section. The Credit Risk Management section describes how we manage on- and off-balance sheet credit risk. Liquidity Agreements We arrange financing for certain customer transactions through multi-seller commercial paper conduits that provide customers with access to the commercial paper market. Conduits purchase a variety of asset-backed loans and receivables, trade receivables, securities and other assets from borrowers and issuers, and issue commercial paper to fund those assets. We provide a liquidity facility on substantially all the commercial paper issued by the conduit we administer. The conduit is considered a VIE under the provisions of FIN 46R, and our liquidity facility exposure is considered a variable interest, although we are not the primary beneficiary. The deconsolidated conduit had $11.4 billion of commercial paper outstanding at December 31, 2006. We also provide liquidity on certain transactions of the structured lending vehicle we administer. The vehicle is a VIE and our liquidity facility exposure along with certain other interests are considered variable interests. We are not the primary beneficiary and do not consolidate the vehicle. The structured lending vehicle had total assets with a fair value of $7.6 billion at December 31, 2006. We securitize assets originated through our normal loan production channels or purchased in the open market, including fixed rate municipal bonds. In securitization transactions, assets are typically sold to a QSPE, which then issues beneficial interests in the form of senior and subordinated interests, including residual interests, collateralized by the assets. The QSPE is a legally distinct, bankruptcy remote entity that is used in these transactions to isolate the cash flows associated with the assets from originator default. This legal isolation and the allocation of risk to different tranches of securities issued by the QSPE allow securitization transactions to generally receive cost-advantaged funding rates. In certain cases, the investors in the debt issued by the QSPE are conduits that are administered by other parties. We provide liquidity agreements on the commercial paper issued by the conduits to fund the purchase of the QSPE’s debt. The provisions of the liquidity agreements require us to purchase an interest in the assets financed by the conduits if the conduits are unable to continue to issue commercial paper to finance those assets. The ability to market commercial paper is affected by general economic conditions
Guarantees Securities and other lending indemnifications Standby letters of credit Liquidity agreements Loans sold with recourse Residual value guarantees Total guarantees
Guarantees Guarantees are contracts that contingently require us to make payments to a guaranteed party based on an event or change in an underlying asset, liability, rate or index. Our guarantees are generally in the form of securities and other lending indemnifications, standby letters of credit, liquidity agreements, loans sold with recourse or residual value guarantees. Securities and Other Lending Indemnifications We indemnify clients of our securities lending business. Our clients’ securities are loaned, on a fully collateralized basis, to third party broker/dealers. We indemnify our clients against broker default and support these indemnifications with collateral that is marked to market daily. We generally require cash or other highly liquid collateral from the broker/dealer. At December 31, 2006, there was $63.5 billion in collateral supporting the $61.7 billion loaned. There is no carrying amount associated with these indemnifications. Standby Letters of Credit We issue standby letters of credit to customers in the normal course of our commercial lending businesses. Standby letters of credit are guarantees of performance primarily issued to support private borrowing arrangements, including commercial paper, bond financings and similar transactions. We also assist commercial, municipal, nonprofit and other customers in obtaining long-term tax-exempt funding through municipal bond issues and by providing credit enhancements in the form of standby letters of credit. Under these agreements and under certain conditions, if the bondholder requires the issuer to repurchase the bonds prior to maturity and the issuer cannot remarket the bonds, we are obligated to provide funding to the issuer to finance the repurchase of the bonds. We were not required to provide any funding to finance the repurchase of the bonds under these agreements in 2006.
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Wachovia Corporation 2006 Annual Report
and by the credit rating of the party providing the liquidity agreement. To date, there has not been a situation where these conduits could not issue commercial paper. We received fees of $2 million in 2006 and in 2005 for providing these liquidity agreements. In addition, at the discretion of the conduit administrator and in accordance with the provisions of the liquidity agreements, we may be required to purchase assets from the conduits we administer and/or those administered by third parties. In some cases, the fair value of the assets may be less than their par value, and consequently, we record a loss for the difference between these values. Any losses for assets purchased from the deconsolidated conduit would be after losses absorbed by the third-party holder of the subordinated note. In 2006 and in 2005, we did not have significant losses associated with these purchases. We received fees of $84 million in 2006 and $69 million in 2005 for servicing assets held by QSPEs to which we provide liquidity or in which we have retained interests. In fixed rate municipal bond securitizations, similar to other securitization transactions, the bonds are sold to a QSPE, which issues short-term tax-exempt securities and residual interests collateralized by the assets. Investors purchase these tax-exempt debt securities and generally we retain the residual interests. We also provide liquidity agreements on these debt securities issued by the QSPEs. The market for tax-exempt securities is generally very liquid, but in the event the debt securities could not be remarketed due to market conditions, the liquidity agreements would require us to purchase the debt securities from the QSPE at par value. Loans Sold with Recourse In certain loan sales or securitizations, we provide recourse to the buyer that requires us to repurchase loans at par value plus accrued interest on the occurrence of certain credit-related events within a certain period of time. In many cases, we are able to recover amounts paid from the sale of the underlying collateral. In 2006 and in 2005, we did not repurchase a significant amount of loans associated with these agreements. Residual Value Guarantees We provide residual value guarantees as part of certain leasing transactions of corporate assets, including railcars, office buildings and corporate aircraft. The lessors in these leases are generally large financial institutions or their leasing subsidiaries. These guarantees protect the lessor from loss on sale of the related asset at the end of the lease term. To the extent that a sale results in proceeds less than a stated percent (generally 80 percent to 89 percent) of the asset’s cost less depreciation, we would be required to reimburse the lessor under our guarantee. Residual value guarantees outstanding at December 31, 2006, included $1.1 billion representing assets under operating leases, of which $852 million related to operating leases of railcars.
Retained Interests As discussed above, we periodically securitize assets originated through our normal loan production channels or warehoused on behalf of clients through purchases in the open market. In securitization transactions, assets are typically sold to off-balance sheet, special purpose entities. Certain securitization transactions result in a complete transfer of risk to investors, and in others, we retain risk in the form of senior or subordinated notes or residual interests in the securities issued by the off-balance sheet entities. Retained interests from securitizations recorded as either available for sale securities, trading account assets or loans amounted to $8.2 billion at December 31, 2006, and $6.4 billion at December 31, 2005. In 2006, we securitized and sold $3.2 billion of consumer loans, retaining $97 million in the form of residual interests. Included in other income were net gains of $9 million in 2006 related to these securitizations. This compares with net gains of $10 million related to securitizations in 2005, when we securitized and sold $9.6 billion of consumer loans, retaining $191 million in the form of investment grade securities and $210 million in the form of residual interests. We have credit, liquidity and market risk associated with our retained interests. Determining the fair value of our retained interests is subjective and is described in more detail in the Critical Accounting Policies section. In addition, the Securities section includes further information.
Risk Governance and Administration
Overview Our business exposes us to several risk types including strategic business risks, credit, market, liquidity, operational, compliance, reputation, litigation and other risks. Our corporate risk governance structure enables us to weigh risk and return to produce sustainable revenue, reduce earnings volatility and increase shareholder value. Board of Director Committees and Management Operating Committee Our risk governance structure begins with our board of directors, which evaluates risk and oversees the management of risk through its Risk Committee and Audit Committee. The board of directors has approved management accountabilities and supporting committee structures to effect risk governance. Our chief executive officer is responsible for the overall risk governance structure. Our chief risk officer reports directly to our chief executive officer and is responsible for independent evaluation and oversight of our credit, market and operational risk-taking activities and our risk governance processes. We oversee strategic business risk and our general business affairs through the Management Operating Committee. This committee meets monthly and is composed of the senior management of the company, including all executives who report directly to the chief executive officer.
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33
Management’s Discussion and Analysis
Four Components of Risk Governance Our risk management strategy is aligned around four components of risk governance: our business units; our independent risk management function joined by other corporate staff functions including legal, finance, human resources and technology; internal audit; and risk committees. Our business units are responsible for identifying, acknowledging, quantifying, mitigating and managing all risks. Business unit management determines and executes our strategies, which puts them closest to the changing nature of risks, and makes them best able to take action to manage and mitigate those risks. Our management processes, structure and policies help us to comply with laws and regulations, and provide clear lines of sight for decision-making and accountability. Our risk management organization provides objective oversight of our risk-taking activities and translates our overall risk appetite into approved limits. Risk management works with the business units and functional areas to establish appropriate standards and also monitors business practices in relation to those standards. Risk management proactively works with the businesses and senior management to ensure we have continuous focus on key risks in our businesses and emerging trends that may change our risk profile. Our internal audit group, which reports directly to the Audit Committee of the board of directors, provides an objective assessment of the design and execution of our internal control system including our management systems, risk governance, and policies and procedures. Internal audit activities are designed to provide reasonable assurance that resources are safeguarded; that significant financial, managerial and operating information is complete, accurate and reliable; and that employee actions comply with our policies and applicable laws and regulations. Our risk committees provide a mechanism to bring together the many perspectives of our management team to discuss emerging risk issues, monitor risk-taking activities and evaluate specific transactions and exposures. All risk committees ultimately report to the Senior Risk Committee, which is chaired by the chief executive officer, which in turn reports to the board of directors, and is composed of certain members of the Management Operating Committee. The Senior Risk Committee is charged with monitoring the direction and trend of risks relative to business strategies set by the Management Operating Committee and relative to market conditions and other external factors. It reviews identified emerging risks and directs action to appropriately mitigate those risks. This committee also ensures that responsibilities and accountabilities for risk management and corrective action on control matters are properly delegated to appropriate individuals and implemented on a timely basis. The Senior Risk Committee
directly oversees the activities of these five key management committees: Credit Risk, Market Risk, Operational Risk, Asset and Liability, and Conflicts of Interest. Credit Risk Management Credit risk is the risk of loss due to adverse changes in an issuer’s, borrower’s or counterparty’s ability to meet its financial obligations under agreed upon terms. The nature and amount of credit risk depends on the type of transaction, the structure of that transaction and the parties involved. While we are subject to some credit risk in our trading, investing, liquidity, funding and asset management activities, it is typically only incidental in these businesses. Credit risk is central to the profit strategy in lending and other financing activities, and as a result, the majority of our credit risk is associated with these activities. Credit risk is managed through a combination of policies and procedures and authorities that are tracked and regularly updated in a centralized database. The board of directors grants credit authority to the chief executive officer, who in turn, has delegated that authority to the chief risk officer. Credit authorities are further delegated through the independent risk management organization. Most authority to approve credit exposure is granted to officers in the risk management organization, who are experienced in the industries and loan structures over which they have responsibility, and are independent of the officers who are responsible for generating new business. There are two processes for approving credit risk exposures. The first process involves standard approval structures (such as rapid decision scorecards) for use in retail, certain small business lending and most trading activities. The second process involves individual approval of commercial exposures based, among other factors, on the financial strength of the borrower, assessment of the borrower’s management, industry sector trends, the type of exposure, the transaction structure and the general economic outlook. Credit Risk Review is an independent unit that performs risk process reviews and evaluates a representative sample of individual credit extensions. Credit Risk Review has the authority to change internal risk ratings and has the responsibility to assess the adequacy of credit underwriting and servicing practices. This unit reports directly to the Risk Committee of the board of directors. Economic capital for all credit risk assets is calculated by the credit risk management group within the risk management organization. Commercial Credit All commercial exposures, both in the form of loans and commitments to lend, are assigned internal risk ratings that reflect the probability of borrower default on any obligation and the probable loss in the event of a default. Commercial credit extensions are also evaluated
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Wachovia Corporation 2006 Annual Report
VAR Profile by Risk Type
(In millions)
2006 High $ 11.2 3.7 34.8 20.3 0.9 $ 31.1 Low 4.6 0.2 14.3 1.3 0.2 12.8 Avg 6.8 0.9 21.2 10.1 0.4 19.0 High 25.9 2.1 – 16.2 1.3 28.4
2005 Low 10.0 0.2 – 5.6 0.1 11.9 Avg 15.1 0.8 – 10.4 0.5 19.2
Risk Category Interest rate Foreign exchange Credit products Equity Commodity Aggregate
Daily VAR Backtesting
(Dollars of revenue in millions)
$20 $10 $0 ($10) ($20) ($30) ($40) 01/03/06 P/L VAR (General Risk) 12/27/06
Borrower exposures may be designated as “watch list” accounts when warranted as a result of either environmental factors or individual company performance. Such accounts are subjected to additional review by the business line management, risk management and credit risk review staffs, and our chief risk officer in order to adequately assess the borrower's credit status and to take appropriate action. In addition, projections of both nonperforming assets and losses for future quarters are performed monthly. We have also established special teams composed of highly skilled and experienced lenders to manage problem credits and to handle commercial recoveries, workouts and problem loan sales. Commercial credit checks and balances, the independence of risk management functions and specialized processes are all designed to avoid credit problems where possible, and to recognize and address problems early when they do occur. Retail Credit In retail lending, we manage credit risk primarily from a portfolio view. The risk management division, working with the lines of business, determines the appropriate risk and return profile for each portfolio, using a variety of tools including quantitative models and scorecards tailored to meet our specific needs. By incorporating these models and policies into computer programs or “decisioning engines,” much of the underwriting is automated. Once a line of credit or other retail loan is extended, it is included in the overall portfolio, which is continuously monitored for changes in delinquency trends and other asset quality indicators. Delinquency action on individual credits is taken monthly or as needed if collection efforts are required. Market Risk Management Market risk represents the risk of declines in value that on- and off-balance sheet positions could realize depending on a variety of market movements, such as changes in interest rates, equity prices and foreign exchange rates. We trade a variety of equities, debt securities, foreign exchange instruments and other derivatives to provide customized solutions for the risk management needs of our customers and for proprietary trading. Market risk is inherent in all these activities. Market risk management activities are overseen by an independent market risk group, which reports outside the business units to the risk management group. Risk measures include the use of value-at-risk (VAR) methodology with limits approved by the Market Risk Committee and subsequently by the Risk Committee of the board. The Market Risk Committee also approves a variety of other trading limits designed to match trading activities to our appetite for risk and to our strategic objectives. The VAR methodology assesses market volatility over the most recent 252 trading days to estimate within a given
Histogram of Daily Profit and Loss in 2006
(Dollars of revenue in millions)
55 50 45 Number of Days 40 35 30 25 20 15 10 5 ($9) ($11) ($7) ($5) ($3) ($1) $13 $1 1 $15 $3 0 $17 $5 $7 $1 $9
using a RAROC model that considers pricing, internal risk ratings, loan structure and tenor, among other variables. This produces a risk and return analysis, enabling the efficient use of economic capital attributable to credit risk. The Credit Risk Committee approves policy guidelines that limit the maximum level of credit exposure to individual commercial borrowers or a related group of borrowers. These guidelines are based on the internal ratings associated with the credit facilities extended to each borrower as well as on the economic capital associated with them. Concentration risk is also managed through geographic and industry diversification and loan quality factors. The Credit Risk Committee approves industry concentration and country exposure limits.
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35
Management’s Discussion and Analysis
level of confidence the maximum trading loss over a period of time that we would expect to incur from an adverse movement in market rates and prices over the period. We calculate 1-day VAR at the 97.5 percent and 99 percent confidence levels, and 10-day VAR at the 99 percent confidence level. The VAR model is supplemented by stress testing on a daily basis. The analysis captures all financial instruments that are considered trading positions. Our 1-day VAR limit in 2006 was $30 million. The total 1-day VAR was $30 million at December 29, 2006, and $18 million at December 31, 2005, and primarily related to interest rate risk and equity risk. The high, low and average VARs in 2006 were $31 million, $13 million and $19 million, respectively. Operational Risk Management Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. This risk is inherent in all our businesses. Operational risk is divided into the following functional risk areas: vendor risk, compliance, technology, financial, fiduciary, human capital, business continuity planning, legal, change and implementation risk, and internal and external fraud. Operational risk is managed through an enterprise-wide framework for organizational structure, processes and technologies. This framework has been developed and implemented by an independent operational risk team that reports to the risk management group. This team is composed of a corporate operational risk group and operational risk leaders aligned with our business units and support functions. In addition to our governance process, we devote significant emphasis and resources to continuous refinement of processes and tools that aid us in proactive identification and management of material operational risks, including a rigorous self-assessment process. Additionally, we focus on training, education and development of a risk management culture that reinforces the message that all employees are responsible for the management of operational risk. We believe proactive management of operational risk is a competitive advantage due to lower earnings volatility, greater customer satisfaction and enhanced reputation. One component of operational risk is compliance risk. This risk is managed by our compliance group, which works within the business lines but reports centrally to the risk management group under the leadership of our chief compliance officer, who reports to our chief executive officer. This structure allows compliance risk management to consult with the business unit as policies and procedures are developed, and it enables close monitoring of daily activities. As part of our compliance program, we devote significant resources to combat money laundering and terrorist financing, and to safeguard our customers’ data. Managing merger risk and change in general is another key component of operational risk. We use a well-documented, disciplined process to manage the inherent risk of change
(for example, merger integrations, outsourcing and new product developments) and to assess organizational readiness. The organizational readiness assessment process provides readiness and risk information related to staffing, training, customer communication, compliance, vendors, corporate real estate, technology infrastructure, application systems, operational support and reconcilement. We pay close attention to the overall organizational capacity and interdependencies, and to our ability to execute. To further strengthen our governance processes, we combined our financial and implementation risk governance committees into a single investment review board in 2006. This committee provides executive management oversight to the portfolio of significant projects. We also focus on managing other key operational risks such as business continuity, reliance on vendors, and privacy and information security. These risks are not unique to our institution and are inherent in the financial services industry. We link business performance measurements to operational risk through risk profiles, quality of the internal controls and capital allocation. Liquidity Risk Management Liquidity risk involves the risk of being unable to fund assets with the appropriate duration and rate-based liabilities, as well as the risk of not being able to meet unexpected cash needs. In our liquidity management process, we focus on both assets and liabilities and on the manner in which they combine to provide adequate liquidity to meet our needs. The Liquidity Risk Management table focuses only on future obligations. In this table, all deposits with indeterminate maturities, such as demand deposits, checking accounts, savings accounts and money market accounts, are presented as having a maturity of one year or less. Funding sources primarily include customer-based core deposits, purchased funds, collateralized borrowings, cash flows from operations, and asset securitizations and sales. Liquidity Risk Management
December 31, 2006
Over One Over Three One Year Year Through Years Through or Less Three Years Five Years Over Five Years
(In millions)
Total
Contractual Commitments Deposit maturities Long-term debt Operating lease obligations Capital lease obligations Investment obligations Other purchase obligations Total $407,458 138,594 6,195 16 844 655 $553,762 395,527 31,131 687 3 844 428 428,620 8,633 39,509 1,258 5 – 181 49,586 3,207 30,228 1,803 4 – 46 35,288 91 37,726 2,447 4 – – 40,268
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Wachovia Corporation 2006 Annual Report
Cash flows from operations are a significant component of liquidity risk management and consider both deposit maturities and the scheduled cash flows from loan and investment maturities and payments, along with dividend payments. We purchase funds on an unsecured basis in the federal funds, commercial paper, bank note, national certificate of deposit and long-term debt markets. In addition, we routinely use securities in our trading portfolio and in our available for sale portfolio as collateral for secured borrowings. In the event of severe market disruptions, we have access to secured borrowings through the Federal Reserve Bank. Our ability to access unsecured funding markets and the cost of funds acquired in these markets are primarily dependent on our credit rating, which is currently P-1/A-1+/F1+ for short-term paper and Aa3/AA-/AAfor senior debt (Moody’s, Standard & Poor’s and Fitch, respectively). Our goal is to maintain a long-term AA credit rating. We believe a long-term credit rating of AA will provide us with many benefits, including access to additional funding sources at lower rates (assuming a static interest rate environment). Conversely, a downgrade from our current long-term debt ratings would have an adverse impact, including higher costs of funds, access to fewer funding sources and possibly the triggering of liquidity agreements. Providing funding under liquidity agreements could result in our forgoing more profitable lending and investing opportunities as well as dividend payments because of funding constraints. Asset securitizations provide an alternative source of funding. Except for the customer-oriented conduit activities, we do not rely heavily on the securitization markets as a source of funds but instead we use securitizations to diversify risk and manage regulatory capital levels. Widening of the credit spreads in the securitization market may make accessing these markets undesirable. If securitizations become undesirable, we may discontinue certain lending activities and/or increase our reliance on alternative funding sources. The Asset and Liability Committee is responsible for liquidity risk management. This committee approves liquidity limits and receives thorough periodic reports on our liquidity position. Liquidity reports detail compliance with limits and with guidelines. They include a review of forecasted liquidity needs based on scheduled and discretionary asset and liability maturities. They evaluate the adequacy of funding sources to meet these needs. In addition, stress tests are evaluated to determine required levels of funding in an adverse environment. These stress tests include reduced access to traditional funding sources in addition to unexpected draw-downs of contingent liquidity exposures (for example, liquidity agreements with conduits). Derivatives We use derivatives to manage our exposure to interest rate risk, to generate profits from proprietary trad-
ing and to assist our customers with their risk management objectives. All derivatives are recorded on the balance sheet at fair value with realized and unrealized gains and losses included either in the results of operations or in other comprehensive income, depending on the nature, purpose and designation of the derivative transaction. Derivative transactions are often measured in terms of notional amount, but this amount is not recorded on the balance sheet and is not, when viewed in isolation, a meaningful measure of the risk profile of the instruments. The notional amount is not usually exchanged, but is used only as the basis on which interest or other payments are calculated. For interest rate risk management, we use derivatives as a cost- and capital-efficient way to hedge on-balance sheet assets, liabilities and future financial transactions. Derivatives used for interest rate risk management include various interest rate swap, futures, forward and option structures with indices that relate to the pricing of specific on-balance sheet instruments. Trading and customer derivatives include a wide array of interest rate, commodity, foreign currency, credit and equity derivatives. Swap contracts are commitments to settle in cash at a future date or dates, which may range from a few days to a number of years, based on differentials between specified financial indices as applied to a notional principal amount. Futures and forward contracts are commitments to buy or sell at a future date a financial instrument, commodity or currency at a contracted price and may be settled in cash or through delivery. Option contracts give the purchaser, for a fee, the right, but not the obligation, to buy or sell within a limited time, a financial instrument or commodity at a contracted price that may also be settled in cash, based on differentials between specified indices. Credit derivatives are contractual agreements that in exchange for a fee provide insurance against a credit event including bankruptcy, insolvency, credit downgrade and failure to meet payment obligations of one or more referenced credits. We measure credit exposure on our derivative contracts by taking into account both the current market value of each contract in a gain position, which is reported on the balance sheet, and a prudent estimate of potential change in value over each contract’s life. The measurement of the potential future exposure for each derivative is based on a simulation of market rates and generally takes into account legally enforceable risk mitigating agreements for each obligor such as netting and collateral. We manage the credit risk of these instruments in much the same way we manage credit risk of our loan portfolios, by establishing credit limits for each counterparty and by requiring collateral agreements for dealer transactions. For nondealer transactions, the need for collateral is evaluated on an individual transaction basis and is primarily dependent
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37
Management’s Discussion and Analysis
on the financial strength of the counterparty. Credit risk is also reduced significantly by entering into legally enforceable master netting agreements. When we have more than one transaction with a counterparty and there is a legally enforceable master netting agreement in place, the exposure represents the net of the gain and loss positions with that counterparty. The Credit Risk Management section has more information on the management of credit risk. The market risk associated with interest rate risk management derivatives is fully incorporated into our earnings simulation model in the same manner as financial instruments for which the interest-bearing balance is reflected on the balance sheet. The Interest Rate Risk Management section describes the way in which we manage this risk. The market risk associated with trading and customer derivative positions is managed using VAR methodology, as described in the Market Risk Management section. More information on our derivatives used for interest rate risk management is included in applicable Notes to Consolidated Financial Statements. Interest Rate Risk Management One of the fundamental roles in banking is the management of interest rate risk, or the risk that changes in interest rates may diminish net interest income we earn on loans, securities and other earning assets. The following discussion explains how we oversee the interest rate risk management process and describes the actions we take to protect earnings from interest rate risk. A balance sheet is considered asset sensitive when its assets (loans and securities) reprice faster or to a greater extent than liabilities (deposits and borrowings). An assetsensitive balance sheet will produce more net interest income when interest rates rise and less net interest income when interest rates decline. Historically, our large and relatively rate-insensitive deposit base has funded a portfolio of primarily floating rate commercial and consumer loans. This mix naturally creates a highly asset-sensitive balance sheet. Furthermore, our focus on new customer acquisition and quality customer service has historically enabled us to generate deposit growth that has matched or outpaced loan growth, adding to our naturally asset-sensitive position. To achieve more neutrality or to establish a liability-sensitive position, we maintain a large portfolio of fixed rate discretionary instruments such as loans, securities and derivatives. We often elect to use derivatives to protect assets, liabilities and future financial transactions from changes in interest rates. When deciding whether to use derivatives instead of investing in securities to reach the same goal, we consider a number of factors, such as cost, efficiency, the effect on our liquidity and capital, and our overall interest rate risk management strategy. We choose to use derivatives when they provide greater relative value or more efficient execu-
Market Rate Scenarios
7% 6% 5% 4% 3% 2% 1% Most Likely Rate Alternate Scenario 2 Alternate Scenario 1 High Rate Low Rate 1MO 1YR 2YR 5YR 10YR 30YR
tion of our strategy than securities. The derivatives we use for interest rate risk management include various interest rate swaps, futures and forwards and in many cases are designated and accounted for as accounting hedges. We fully incorporate the market risk associated with interest rate risk management derivatives into our earnings simulation model in the same manner as other on-balance sheet financial instruments. We analyze and manage the amount of risk we are taking to changes in interest rates by forecasting a wide range of interest rate scenarios for time periods as long as 36 months. In analyzing interest rate sensitivity for policy measurement, we compare forecasted earnings per share in both “high rate” and “low rate” scenarios to the “market forward rate.” The policy measurement period is 12 months in length, beginning with the first month of the forecast. Our objective is to ensure we prudently manage interest-bearing assets and liabilities in ways that improve financial performance without unduly putting earnings at risk. Our policy is to limit the risk we can take through balance sheet management actions to 5 percent of earnings per share in both falling and rising rate environments. The “market forward rate” is constructed using currently implied market forward rate estimates for all points on the yield curve over the next 36 months. Our standard approach evaluates expected earnings in a 400 basis point range, or 200 basis points both above and below the “market forward rate” scenario. Based on our January 2007 forward rate expectation, our various scenarios together measure earnings volatility to a December 2007 federal funds rate ranging from 2.78 percent to 6.78 percent. We simultaneously measure the impact of a parallel and nonparallel shift in rates on each of our interest rate scenarios. A parallel shift would, as the term implies, shift all points on the yield curve by the same increments. For example, by the twelfth month in our policy measurement period, short-term rates such as the federal funds rate would increase by 200 basis points over the “market forward rate,” while longer term rates such as the 10-year treasury note rate and 30-year treasury note rate would increase by 200 basis points as well. A nonparallel shift would consist
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Wachovia Corporation 2006 Annual Report
of a 200 basis point increase in short-term rates, while long-term rates would increase by a different amount. A rate shift in which short-term rates rise to a greater degree than long-term rates is referred to as a “flattening” of the yield curve. Conversely long-term rates rising to a greater degree than short-term rates would lead to a steepening of the yield curve. The impact of a nonparallel shift in rates depends on the types of assets in which funds are invested and the shape of the yield curve implicit in the “market forward rate” scenario. In the first six months of 2004, the threat of rising rates, but uncertain timing, kept the yield curve very steep. Before the Federal Reserve’s Federal Open Market Committee’s tightening campaign began in late June 2004, our investment and hedging strategies were designed to manage both repricing risk and curve flattening that typically accompanies a rapid rise in short-term rates. Much of the anticipated flattening occurred throughout 2004, 2005 and 2006. At December 31, 2006, the spread between the 10-year treasury note rate and the federal funds rate was inverted at a negative 46 basis points, which is considerably different from the long-term average spread of a positive 119 basis points. While we still believe further inversion is possible, and we will continue to measure the impact of a nonparallel shift in rates, we feel the risk of earnings volatility due to further inversion has somewhat subsided. Considering the balance of risks for 2007, we will focus primarily on managing the value created through our expanded deposit base as we protect the net interest margin against the pressures of higher short-term rates, and relative to prior years, a flatter yield curve. We expect to rely on our large base of low-cost core deposits to fund incremental investments in loans and securities. The characteristics of the loans we add will prompt different strategies. Fixed rate loans, for example, diminish the need to buy discretionary investments, so if more fixed rate loans were added to our loan portfolio, we would likely allow existing discretionary investments to mature or we would liquidate them. If more variable rate loans were added to our loan portfolio, we would likely allow fixed rate securities to mature or we would liquidate them, and then add new derivatives that, in effect, would convert the incremental variable rate loans to fixed rate loans. For example, Golden West option ARMs, despite being a monthly floating rate product, reprice on an index that generally lags changes in short-term rates. A portion of these option ARMs are funded with short-term floating rate notes, which together create a profile that is liability-sensitive as measured under our earnings sensitivity analysis. Therefore, in advance of the Golden West merger, we reduced the size of our fixed rate exposure in residential mortgage-backed securities and commercial mortgage-backed securities in order to help achieve the desired interest rate risk profile for the combined company.
Policy Period Sensitivity Measurement
Actual Fed Funds Rate at January 1, 2007
(a)
(In percent)
Implied Fed Funds Rate at December 31, 2007
Percent Earnings Sensitivity
Market Forward Rate Scenarios
5.25 %
4.78 6.78 2.78
– (1.9) 3.6
High Rate Composite Low Rate
(a)
Assumes base federal funds rate mirrors market expectations.
Earnings Sensitivity The Policy Period Sensitivity Measurement table provides a summary of our interest rate sensitivity measurements. The January 2007 forward rate expectations imply a high probability that the federal funds rate will decline 50 basis points by the end of the policy period in December 2007. If this occurs, the spread between the 10-year treasury note rate and the federal funds rate would compress from a negative 67 basis points of slope in January 2007, to a less inverted yield curve of a negative 22 basis points of slope by December 2007. Because it is unlikely under this scenario that federal fund rates would rise an additional 200 basis points in parallel, our high rate sensitivity to the “market forward rate” scenario is measured using three different yield curve shapes. These yield curves are constructed to represent the more likely range of yield curve shapes that may prevail in an environment where short-term rates rise 200 basis points above current market expectations. The reported high rate sensitivity is a composite of these three scenarios. In January 2007, our earnings simulation model indicated earnings would be negatively affected by 1.9 percent in a “high rate composite” scenario relative to the “market forward rate” over the policy period. Additionally, we measure a scenario where short-term rates gradually decline 200 basis points over a 12-month period while the longer-term 10-year treasury note rate and the 30-year treasury note rate each decline by less than 200 basis points relative to the “market forward rate” scenario. The model indicates earnings would be positively affected by 3.6 percent in this scenario. These percentages are for a full year, but may be higher or lower in individual reporting periods. While our interest rate sensitivity modeling assumes management takes no action, we regularly assess the viability of strategies to reduce unacceptable risks to earnings and we implement such strategies when we believe those actions are prudent. As new monthly outlooks become available, we formulate strategies aimed at protecting earnings from the potential negative effects of changes in interest rates. Financial Disclosure We have always maintained internal controls over financial reporting, which generally include those controls relating to the preparation of our consolidated financial statements in conformity with GAAP. As a bank holding company, we are subject to the internal control
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Management’s Discussion and Analysis
reporting and attestation requirements of the Federal Deposit Insurance Corporation Improvement Act, and therefore, we are very familiar with the process of maintaining and evaluating our internal controls over financial reporting. We also are focused on our disclosure controls and procedures, which as defined by the SEC, are generally those controls and procedures designed to ensure that financial and non-financial information required to be disclosed in our reports filed with the SEC is reported within the time periods specified in the SEC’s rules and forms, and that such information is communicated to management, including our chief executive officer and our chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. Our Disclosure Committee, which includes senior representatives from our treasury, risk, legal, accounting and investor relations departments, as well as from our four core business segments, assists senior management in its oversight of the accuracy and timeliness of our disclosures, as well as in implementing and evaluating our overall disclosure process. As part of our disclosure process, accounting representatives in our finance division and representatives from our four core business segments prepare and review monthly, quarterly and annual financial reports, which also are reviewed by each of the business segment’s chief financial officers and senior management. Accounting representatives in our finance division also conduct further reviews with our senior management team, other appropriate personnel involved in the disclosure process, including the Disclosure Committee and internal audit, and our independent auditors and counsel, as appropriate. Financial results and other financial information also are reviewed with the Audit Committee of the board of directors on at least a quarterly basis. In addition, accounting representatives in our finance division meet with representatives of our primary federal banking regulators on a quarterly basis to review, among other things, income statement and balance sheet trends, any significant or unusual transactions, changes in or implementation of significant accounting policies, and other significant non-financial data, as identified by our representatives. The chief executive officer and the chief financial officer also meet with the federal banking regulators on a semiannual basis. As required by applicable regulatory law, the chief executive officer and the chief financial officer review and make various certifications regarding the accuracy of our periodic public reports filed with the SEC, our disclosure controls and procedures, and our internal control over financial reporting. Assisted by the Disclosure Committee, we will continue to assess and monitor our disclosure controls and procedures, and our internal controls over financial reporting, and we will make refinements as necessary.
Accounting and Regulatory Matters
The following information addresses significant new developments in accounting standard setting that will affect us, as well as new or proposed legislation that will continue to have a significant impact on our industry. Income Taxes In July 2006, the FASB issued FIN 48, which clarifies the criteria for recognition and measurement of income tax benefits in accordance with SFAS 109, Accounting for Income Taxes. Under FIN 48, evaluation of income tax benefits is a two-step process. First, income tax benefits can be recognized in financial statements for a tax position only if it is considered “more likely than not,” as defined in SFAS 5, Accounting for Contingencies, of being sustained on audit based solely on the technical merits of the income tax position. Second, if the recognition criteria are met, the amount of income tax benefits to be recognized is measured based on the largest income tax benefit that is more than 50 percent likely to be realized on ultimate resolution of the tax position. See below for a discussion of the impact of FIN 48 for leveraged lease transactions. FIN 48 became effective on January 1, 2007, and the impact of adopting FIN 48 on other positions did not have a material impact on our consolidated financial position. Leveraged Lease Accounting In July 2006, the FASB issued FASB Staff Position FAS 13-2, Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction, (FSP 13-2). FSP 13-2 amends SFAS 13, Accounting for Leases, to provide that changes affecting the timing of income tax cash flows but not the total net income under a leveraged lease trigger a recalculation of the net investment in the lease. Prior to FSP 13-2, only a change in an important lease assumption that changed the total estimated net income under a leveraged lease triggered a recalculation of the net investment. Under FSP 13-2, recalculations affecting existing leveraged leases result in a one-time noncash charge to be recorded as a cumulative effect of a change in accounting principle through a reduction of beginning retained earnings on January 1, 2007. Amounts that in the aggregate approximate the amount of the charge initially recorded will be recognized as income over the remaining terms of the affected leases. Any additional recalculations for subsequent changes in the timing of income tax cash flows will be recorded in the results of operations. We have two primary classes of leveraged lease transactions that are affected by FSP 13-2: Lease-In, Lease-Out transactions (LILOs) and a second group of transactions the Internal Revenue Service broadly refers to as SILOs. SILOs principally include service contract and qualified technological equipment leases. As previously disclosed, in 2004, Wachovia and the IRS settled all issues relating to the IRS’s challenge of the tax
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Wachovia Corporation 2006 Annual Report
position on LILOs entered into by First Union Corporation and legacy Wachovia Corporation. The resolution of these LILO issues with the IRS led to a change in the timing of cash flows under the lease transactions, and accordingly, FSP 13-2 requires a recalculation of the LILO leases. FSP 13-2 also affects our SILOs. The IRS has announced its intention to challenge the industry-wide tax treatment of SILOs. While we believe our tax treatment of SILOs is consistent with well-established tax law and that it is more likely than not that we would prevail if litigation were to become necessary, it is possible that, upon resolution of a potential dispute with the IRS, we may not realize some of the income tax benefits originally recorded. Because of this possibility, the combination of FSP 13-2 and FIN 48 requires that we estimate the timing of income tax benefits to recognize and recalculate the net investment in the leases. We have completed our assessment of the impact of FSP 13-2 and FIN 48 on our leveraged lease portfolio, and on January 1, 2007, we recorded a $1.4 billion after-tax charge to beginning retained earnings related solely to our portfolio of LILOs and SILOs. The impact of FSP 13-2 on our regulatory capital is discussed in the Outlook section. The amount of the reduction to January 1, 2007, beginning retained earnings from the affected LILO and SILO transactions will be recognized as income over the remaining terms of the affected leases, generally 35 years to 40 years. The amounts to be recognized as income over the remaining terms of the affected leases will not have a material impact to our results of operations in future periods. Financial Instruments The FASB has an ongoing project addressing the accounting for the transfer of financial instruments and retention of an interest in such financial instruments. As part of this project, the FASB issued two pronouncements in 2006, SFAS 155, Accounting for Certain Hybrid Financial Instruments, (SFAS 155), which is discussed below, and SFAS 156, Accounting for Servicing of Financial Assets, which we implemented effective January 1, 2006, and is discussed in applicable Notes to Consolidated Financial Statements. The FASB is continuing its deliberations relating to an amendment to SFAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities, (SFAS 140). This amendment would revise or clarify the criteria for derecognition of financial assets after a transfer and address the permitted activities of a QSPE. The FASB is considering the need for clarifying guidance, which may result in changes to the structure of and/or the accounting for these transactions. We cannot predict with certainty whether any guidance will be issued or what the transition provisions for implementing the guidance will be from these deliberations.
Hybrid Financial Instruments SFAS 155 amends SFAS 133, Accounting for Derivatives and Hedging Activity, and SFAS 140. Hybrid financial instruments contain an embedded derivative within a single instrument, either a debt or equity host contract. SFAS 155 permits entities the option to record certain hybrid financial instruments at fair value as individual financial instruments, with corresponding changes in value recorded in earnings. Prior to this amendment, certain hybrid financial instruments were required to be separated into two instruments, the derivative and the host, and generally only the derivative was recorded at fair value. SFAS 155 also removes an existing exception for evaluating certain interests in securitized assets for embedded derivatives. SFAS 155 is effective for all financial instruments acquired or issued after January 1, 2007. Additionally, SFAS 155 provides a one-time opportunity to elect fair value for hybrid financial instruments existing at the date of implementation other than th0se interests in securitized assets now subject to evaluation for embedded derivitives. For any instruments included in this one-time transition, the difference between the carrying amount of the derivative and host component of the existing hybrid financial instruments and the fair value of the single financial instrument will be recorded as a cumulative effect adjustment to beginning retained earnings. We do not expect the impact of adopting SFAS 155 on January 1, 2007, to have a material impact on stockholders’ equity. Fair Value In September 2006, the FASB issued SFAS 157, Fair Value Measurement, (SFAS 157), which establishes a framework for measuring fair value in U.S. GAAP, expands disclosures about fair value measurement and provides new income recognition criteria for certain derivative contracts. SFAS 157 does not establish any new fair value measurements itself, but applies to other accounting standards that require the use of fair value for recognition or disclosure. In particular, the framework in SFAS 157 will be required for financial instruments for which fair value is elected, such as under SFAS 155 discussed above or under the newly issued SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities. SFAS 157 eliminates the income deferral requirements of Emerging Issues Task Force (EITF) Issue No. 02-03, Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities, for derivative contracts with valuation inputs that are not directly observable from market data. Application of the SFAS 157 framework may also lead to changes in the measurement of fair value in our consolidated financial statements. Any transition adjustments will be recorded as a cumulative effect of a change in accounting principle through an adjustment to beginning retained earnings on the date of adoption. Both SFAS 157 and SFAS 159 are effective January 1, 2008, with earlier implementation permitted on January 1, 2007, provided financial statements for any period in 2007 have not yet been
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Management’s Discussion and Analysis
issued. We are currently assessing the impact of SFAS 157 on our consolidated financial position and results of operations, and we anticipate a January 1, 2008, adoption date. Regulatory Matters Various legislative and regulatory proposals concerning the financial services industry are pending in Congress, the legislatures in states in which we conduct operations and before various regulatory agencies that supervise our operations. Given the uncertainty of the legislative and regulatory process, we cannot assess the impact of any such legislation or regulations on our consolidated financial position or results of operations. For a more detailed description of the laws and regulations governing our business operations, please see our 2006 Annual Report on Form 10-K. In June 2004, the Basel Committee on Bank Supervision published new international guidelines for determining regulatory capital that are designed to be more risk sensitive than the current framework. In the fourth quarter of 2006, the U.S. regulatory agencies published a joint Notice of Proposed Rulemaking (NPR) for Basel II that represents the U.S. version of the international guidelines. Under the NPR, we must develop an implementation plan within six months of the effective date of the final rule with the transitional period for capital calculation to begin within 36 months of the effective date of the final rule. Regulatory efforts in the U.S. for Basel II have experienced continued timing delays, and the date of a final rule remains unknown. The NPR currently proposes to make 2008 the first possible year for a bank to conduct its parallel run (the first step towards Basel II implementation) for measuring regulatory capital under the new regulatory capital rules and the existing general risk-based capital rules. The NPR also proposes 2009-2011 as the first possible years for the transitional periods. We have established necessary project management infrastructure and funding to ensure we will fully comply with the new regulations.
higher loans and deposits primarily due to Golden West and Westcorp, with equally strong fee income growth, and increased net interest income 29 percent, reflecting higher average commercial loans, up 12 percent, and average consumer loans, up 161 percent, including the impact of the acquisitions. Commercial loan growth was led by middle-market and business banking, commercial real estate and large corporate lending, while consumer loan growth was led by higher real estate-secured loans, which included the impact of year-end 2005 loan transfers from loans held for sale, as well as Golden West and Westcorp. Average core deposits rose 26 percent and average low-cost core deposits were up 3 percent. Growth in lower spread loans, a shift in deposit mix and the effects of the inverted yield curve resulted in 16 basis points of margin compression. Fee and other income grew 33 percent, led by record investment banking fees, strength in service charges and higher securitization income. Asset management fees reached a new high, reflecting continued growth in retail brokerage managed account relationships, while commissions reflected improving retail brokerage transaction activity as well. Trading results recovered from losses in the fourth quarter of 2005 and securities gains were higher. Noninterest expense rose 18 percent largely reflecting the acquisitions, and also included higher incentives on revenue growth in the Corporate and Investment Bank and in Capital Management. In the General Bank, a 47 percent increase in revenue was driven by increased loans and deposits primarily reflecting Golden West and Westcorp. In addition, earnings were $1.7 billion on revenue of $4.8 billion. The business mix continued to shift, reflecting customer preference for fixed rate instead of variable rate loans and certificates of deposit over demand deposits. An increase in average loans reflected the addition of $124.0 billion from Golden West and the addition of $13.5 billion from Westcorp. Organic growth was led by middlemarket commercial, business banking and commercial real estate. Deposit growth was led by consumer certificates of deposit and money market funds. Growth in fee and other income of 27 percent included 19 percent growth in consumer service charges and 16 percent growth in interchange income. Noninterest expense growth of 20 percent included the acquisitions, de novo branch activity and costs related to reentering the credit card business. Despite the increased expense, the General Bank’s overhead efficiency ratio improved 909 basis points to 41.98 percent. Increased provision expense was a result of higher retail losses and lower recoveries.
Earnings Analysis for Fourth Quarter 2006
In the fourth quarter of 2006 compared with the fourth quarter of 2005, net income rose 35 percent to $2.3 billion from $1.7 billion, and diluted earnings per common share rose 10 percent to $1.20 from $1.09. These amounts included Golden West in the fourth quarter of 2006, and reflect after-tax net merger-related and restructuring expenses of 1 cent per share in the fourth quarter of 2006 and 2 cents per share in the fourth quarter of 2005. In addition, the fourth quarter a year ago included an after-tax gain of $214 million, or 14 cents per common share, presented as discontinued operations related to the divestiture of our Corporate and Institutional Trust businesses. Results in 2006 included a gain of $46 million after-tax, or 2 cents per share, relating to this divestiture. In the fourth quarter of 2006 compared with the fourth quarter of 2005, Wachovia grew revenue 31 percent on
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Wachovia Corporation 2006 Annual Report
Wealth Management generated modest revenue growth driven by fee and other income growth, including increased commissions and higher banking fees. In addition, a dip in net interest income was due to margin compression, which offset strong momentum in loans and a modest increase in average core deposits. Noninterest expense declined. In the Corporate and Investment Bank, revenue growth of 28 percent was driven by higher advisory and origination activity in corporate client businesses and strength in real estate capital markets. An 8 percent decline in net interest income reflected spread compression in asset-based lending and leasing, lower trading-related interest income and cross-border leasing runoff. A 50 percent increase in fee and other income reflected strength in real estate capital markets, merger and acquisition advisory services, equities under-writing, high grade debt and loan syndications, and improved trading revenue, as well as slightly improved principal investing results. A 26 percent increase in noninterest expense primarily related to higher variable compensation expense on higher revenues. In Capital Management, a 15 percent increase in revenue reflected strength in retail brokerage managed account fees as well as higher brokerage transaction activity. Results also reflected the impact of 2006 acquisitions, higher net interest income, higher asset management fees and higher valuations on investments. Eight percent growth in noninterest expense was primarily due to higher commissions, deferred compensation, other brokerage production costs and acquisitions. Total assets under management of $276.0 billion at December 31, 2006, were up 20 percent from December 31, 2005, including $17.8 billion of assets retained from $24.0 billion transferred to the Parent in the fourth quarter of 2005 in connection with the divested Corporate and Institutional Trust businesses, $10.8 billion in market appreciation, $9.0 billion in net inflows, $5.5 billion in assets from Metropolitan West Capital Management, and $3.2 billion from Golden West. Equity assets reached $100.8 billion, up 22 percent in the same period. In the Parent, total revenue declined $112 million primarily due to the compression of spreads in funding the securities portfolio and lower contribution of hedge-related derivatives, in addition to the wholesale borrowing growth being partially offset by growth in the securities portfolio. An increase in fee and other income of $136 million included $124 million in higher securities gains and fourth quarter 2006 adjustments of $115 million. The increase was partially offset by a $51 million decline in fiduciary fees from the effect of the divested Corporate and Institutional Trust businesses as well as a $24 million decline in trading profits on higher economic hedging losses. Noninterest expense increased $139 million primarily due to the aforementioned fourth quarter 2006 adjustments of $198 million.
Comparison of 2005 with 2004
Results in 2005 include the full year impact of the acquisition of SouthTrust, which closed on November 1, 2004, as well as the gain from the divested Corporate and Institutional Trust businesses in 2005. Corporate Results of Operations In 2005, we earned $6.6 billion in net income, up 27 percent from 2004, and diluted earnings per common share were $4.19, up 10 percent from 2004. Total revenue grew 14 percent to $26.1 billion, with strong balance sheet growth overcoming margin compression largely related to the addition of lower-spread trading assets and the effects of a flattening yield curve. Key factors in these results included 14 percent growth in tax-equivalent net interest income on 20 percent growth in average earning assets due to SouthTrust and to organic growth; 13 percent growth in fee and other income; and 8 percent growth in noninterest expense. The 13 percent increase in fee and other income included the addition of SouthTrust, increased debit card interchange fees, capital markets fees and trading revenues, as well as, in 2005, gains on the sale of equity securities received in settlement of loans. Lower market activity dampened retail brokerage commissions, while growth in managed account assets contributed to higher fiduciary and asset management fees. Total noninterest expense rose 8 percent from 2004, primarily reflecting the SouthTrust addition, increased revenue-based incentive compensation, and continued investments that better positioned us for future earnings growth. Expense growth was offset in part by merger and expense efficiencies. Income taxes based on income from continuing operations were $3.0 billion in 2005, an increase of $614 million from 2004. The related effective income tax rates were 32.05 percent in 2005 and 31.70 percent in 2004. The increase in this rate was primarily the result of higher pretax income in 2005. On a fully tax-equivalent basis, the related income tax rates were 33.59 percent in 2005 and 33.87 percent in 2004. Business Segments General Bank segment earnings were $3.8 billion in 2005, an increase of 26 percent, reflecting 20 percent revenue growth driven by organic growth with strength in low-cost core deposits and higher commercial and consumer loans, as well as higher earning assets related to SouthTrust. Wealth Management’s segment earnings were $248 million, an increase of 24 percent on 19 percent higher revenues due to higher volume in both consumer and commercial lending, deposit growth, Palmer & Cay and improved trust and investment management fees on higher valuations. Noninterest expense rose 16 percent primarily due to the commercial insurance brokerage addition and higher personnel costs. Corporate and Investment Bank segment earnings increased 3 percent to $1.7 billion, reflecting rev-
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Management’s Discussion and Analysis
enue growth of 11 percent as higher fee and other income overcame a decline in net interest income. Noninterest expense rose 18 percent due to higher personnel costs. Capital Management’s segment earnings increased 46 percent as an increase in net interest income and expense efficiencies achieved from retail brokerage integration more than offset lower retail brokerage commissions. Revenue from the asset management businesses declined $12 million to $864 million including a $17 million decline from the 2004 sales of two nonstrategic businesses, partially offset by higher equity assets under management and a modest benefit from SouthTrust. The Parent segment had earnings of $145 million compared with $68 million in 2004. Total revenue in the Parent increased primarily due to higher fee and other income related to a $122 million increase in securities gains and a $117 million increase in other income. Other income included a gain of $38 million associated with the sale of an asset-based lending subsidiary in the United Kingdom and a $35 million increase in income from asset securitizations, which included $74 million of losses related to auto loan securitization activity. Other income in 2004 included a loss of $68 million associated with a sale and leaseback of corporate real estate. Balance Sheet Analysis The majority of the year-over-year 20 percent increase in average earning assets to $428.6 billion in 2005 came from the addition of $49.3 billion in SouthTrust earning assets. The increase in securities available for sale from December 31, 2004, reflected proceeds from deposit growth and higher balance sheet positions, as well as greater use of cash securities in lieu of derivatives to maintain our relatively neutral interest rate risk position. The increase in loans from year-end 2004 reflected 11 percent growth in commercial loans, with an increase in commercial lending activity in the latter half of the year, and 21 percent growth in consumer loans from year-end 2004, which reflected the net impact of transfers from and to loans held for sale, including $12.5 billion of home equity loans transferred to the loan portfolio at year-end 2005. Additionally, the increase reflected movement into fixed rate products, particularly in the home equity market. Nonperforming assets, including loans held for sale, declined 40 percent from 2004.
Provision expense declined 3 percent from 2004, reflecting sustained improvement in credit quality. The allowance for loan losses declined by $33 million from year-end 2004 to $2.7 billion at December 31, 2005, reflecting in part a $53 million reduction related to loans sold or transferred to loans held for sale, as well as to reduced overall risk in the loan portfolio. We sold or securitized $32.8 billion in loans out of the loans held for sale portfolio, including $12.6 billion of commercial loans and $20.2 billion of consumer loans, primarily residential mortgages and home equity loans. Liquidity and Capital Adequacy Core deposits increased 7 percent from December 31, 2004, to $293.6 billion at December 31, 2005. Compared with 2004, average core deposits increased $47.1 billion to $278.7 billion and average low-cost core deposits increased $35.7 billion to $239.0 billion, including SouthTrust. Average purchased funds were $98.7 billion in 2005 and $81.7 billion in 2004. The increase was primarily related to SouthTrust. Purchased funds were $93.3 billion at December 31, 2005, and $83.9 billion at December 31, 2004, reflecting higher foreign and other time deposits, offset by the impact of the fourth quarter 2005 deconsolidation of a conduit we administer. Long-term debt increased $2.2 billion from December 31, 2004, to $49.0 billion at December 31, 2005, and included $1.5 billion of floating rate notes issued by an insurance subsidiary in 2005. Stockholders’ equity increased modestly from year-end 2004 to $47.6 billion at December 31, 2005, including repurchases of 52 million common shares at a cost of $2.7 billion in connection with our share repurchase programs and net depreciation in the securities portfolio. The higher level of share repurchases in 2005 compared with 2004 reflected opportunistic deployment of excess capital partially related to SouthTrust as well as to higher earnings. We paid $3.0 billion, or $1.94 per share, in dividends to common stockholders in 2005 compared with $2.3 billion, or $1.66 per share, in 2004. Our tier 1 capital ratio decreased 51 basis points from December 31, 2004, to 7.50 percent, driven primarily by balance sheet growth.
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Wachovia Corporation 2006 Annual Report
Financial Tables
Table 1 EXPLANATION OF OUR USE OF NON-GAAP FINANCIAL MEASURES
In addition to the results of operations presented in accordance with U.S. generally accepted accounting principles (GAAP), our management uses certain non-GAAP financial measures such as expenses excluding merger-related and restructuring expenses; the dividend payout ratio on a basis that excludes other intangible amortization, merger-related and restructuring expenses, discontinued operations and the cumulative effect of a change in accounting principle; and net interest income on a tax-equivalent basis. We believe these non-GAAP financial measures provide information useful to investors in understanding our underlying operational performance and our business and performance trends, and they facilitate comparisons with the performance of others in the financial services industry. Specifically, we believe the exclusion of merger-related and restructuring expenses permits evaluation and comparison of results for ongoing business operations, and it is on this basis that our management internally assesses our performance. Those non-operating items also are excluded from our segment measures used internally to evaluate segment performance in accordance with GAAP because management does not consider them particularly relevant or useful in evaluating the operating performance of our business segments. For additional information related to segment performance, see the Business Segments section and Note 14 to Notes to Consolidated Financial Statements. This report contains information relating to estimates of our future expenses excluding merger-related and restructuring expenses. The amount and timing of those future merger-related and restructuring expenses, however, are not estimable until such expenses actually occur, and therefore, reconciliation information relating to those future expenses and GAAP expenses has not been provided. In addition, because of the significant amount of deposit base intangible amortization, we believe the exclusion of this expense provides investors with consistent and meaningful comparisons to other financial service firms. Also, our management makes recommendations to our board of directors about dividend payments based on reported earnings excluding other intangible amortization, merger-related and restructuring expenses, discontinued operations and the cumulative effect of a change in accounting principle and has communicated certain dividend payout ratio goals to investors on this basis. We believe this dividend payout ratio is useful to investors because it provides investors with a better understanding of and permits investors to monitor our dividend payout policy. This report also includes net interest income on a tax-equivalent basis. We believe the presentation of net interest income on a tax-equivalent basis ensures comparability of net interest income arising from both taxable and tax-exempt sources and is consistent with industry practice. Although we believe the above mentioned non-GAAP financial measures enhance investors’ understanding of our business and performance, these non-GAAP financial measures should not be considered an alternative to GAAP. The reconciliation of these nonGAAP financial measures from GAAP to non-GAAP is presented below.
Years Ended December 31, (In millions, except per share data) Net interest income (GAAP) Tax-equivalent adjustment Net interest income (Tax-equivalent) DIVIDEND PAYOUT RATIOS ON COMMON SHARES Diluted earnings per common share (GAAP) Other intangible amortization Merger-related and restructuring expenses Discontinued operations (GAAP) Earnings per share (a) Dividends paid per common share Dividend payout ratios (GAAP) (b) Dividend payout ratios (a) (b) $ $ $ 2006 15,249 155 15,404 4.63 0.16 0.07 (0.02) 4.84 2.14 46.22 % 44.21 % 2005 13,681 219 13,900 4.19 0.17 0.11 (0.14) 4.33 1.94 46.30 44.80 2004 11,961 250 12,211 3.81 0.20 0.14 4.15 1.66 43.57 40.00 2003 10,607 256 10,863 2002 9,955 218 10,173
$ $
(a) Excludes other intangible amortization, merger-related and restructuring expenses, and discontinued operations. (b) Dividend payout ratios are determined by dividing dividends per common share by earnings per common share.
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45
Financial Tables
Table 2 SELECTED STATISTICAL DATA Years Ended December 31, (Dollars in millions, except per share data) PROFITABILITY Return on average common stockholders' equity Net interest margin (a) Fee and other income as % of total revenue Effective income tax rate from continuing operations ASSET QUALITY Allowance for loan losses as % of loans, net Allowance for loan losses as % of nonperforming assets (b) Allowance for credit losses as % of loans, net Net charge-offs as % of average loans, net Nonperforming assets as % of loans, net, foreclosed properties and loans held for sale CAPITAL ADEQUACY Tier 1 capital ratio Total capital ratio Leverage Tangible capital ratio Tangible capital ratio (c) OTHER DATA FTE employees Total financial centers/brokerage offices ATMs Registered common stockholders Actual common shares (In millions) Common stock price Market capitalization TOTAL RETURN PERFORMANCE (d) Wachovia S&P 500 BKX 2006 14.36 % 3.12 48.57 32.49 % 0.80 % 246 0.84 0.12 0.32 % 7.42 % 11.33 6.01 4.45 4.75 % 108,238 4,126 5,212 173,486 1,904 56.95 108,443 214.98 135.02 159.87 2005 14.13 3.24 46.78 32.05 1.05 378 1.11 0.09 0.28 7.50 10.82 6.12 4.93 5.06 93,980 3,850 5,119 177,924 1,557 52.86 82,291 191.93 116.61 136.62 2004 14.77 3.41 46.88 31.70 1.23 251 1.30 0.17 0.53 8.01 11.11 6.38 5.15 4.99 96,030 3,971 5,321 185,647 1,588 52.60 83,537 184.03 111.15 132.41 2003 13.25 3.72 46.61 30.16 1.42 205 1.51 0.41 0.69 8.52 11.82 6.36 5.13 4.83 86,114 3,328 4,408 170,205 1,312 46.59 61,139 157.56 100.24 120.08 2002 11.72 3.97 43.68 23.29 1.60 150 1.72 0.73 1.11 8.22 12.01 6.77 5.96 5.34 80,868 3,250 4,560 181,455 1,357 36.44 49,461 119.52 77.90 89.33
$ $ $ $
(a) Tax-equivalent. (b) These ratios do not include nonperforming loans included in loans held for sale. (c) These ratios exclude the effect on tangible capital of the unrealized gains and losses on available for sale securities, certain risk management derivatives and the 2006 pension accounting adjustment discussed in the Stockholders’ Equity section. (d) This information should be read in conjunction with the Total Return 2001-2006 graph on page 2. The information compares (i) the yearly change in the cumulative total stockholder return on Wachovia common stock with (ii) the cumulative return of the Standard & Poor's 500 Stock Index ("S&P 500"), and the Keefe, Bruyette & Woods, Inc. Bank Stock Index ("BKX"). The graph assumes that the value of an investment in Wachovia common stock and in each index was $100 on December 31, 2001, and that all dividends were reinvested. The performance shown in the graph represents past performance and should not be considered an indication of future performance.
46
Wachovia Corporation 2006 Annual Report
Table 3 SUMMARIES OF INCOME, PER COMMON SHARE AND BALANCE SHEET DATA Years Ended December 31, (In millions, except per share data) SUMMARIES OF INCOME Interest income Tax-equivalent adjustment Interest income (a) Interest expense Net interest income (a) Provision for credit losses Net interest income after provision for credit losses (a) Securities gains (losses) Fee and other income Merger-related and restructuring expenses Other noninterest expense Minority interest in income of consolidated subsidiaries Income from continuing operations before income taxes and cumulative effect of a change in accounting principle (a) Income taxes Tax-equivalent adjustment Income from continuing operations before cumulative effect of a change in accounting principle Discontinued operations, net of income taxes Income before cumulative effect of a change in accounting principle Cumulative effect of a change in accounting principle, net of income taxes Net income Dividends on preferred stock Net income available to common stockholders PER COMMON SHARE DATA Basic Income from continuing operations before change in accounting principle Net income Diluted Income from continuing operations before change in accounting principle Net income Cash dividends Average common shares - Basic Average common shares - Diluted Average common stockholders' equity Book value per common share Common stock price High Low Year-end To earnings ratio (b) To book value BALANCE SHEET DATA Assets Long-term debt (a) Tax-equivalent. (b) Based on diluted earnings per common share. $ 2006 32,265 155 32,420 17,016 15,404 434 14,970 118 14,427 179 17,297 414 11,625 3,725 155 7,745 46 7,791 7,791 7,791 2005 23,689 219 23,908 10,008 13,900 249 13,651 89 12,130 292 15,555 342 9,681 3,033 219 6,429 214 6,643 6,643 6,643 2004 17,288 250 17,538 5,327 12,211 257 11,954 (10) 10,789 444 14,222 184 7,883 2,419 250 5,214 5,214 5,214 5,214 2003 15,080 256 15,336 4,473 10,863 586 10,277 45 9,437 443 12,837 143 6,336 1,833 256 4,247 4,247 17 4,264 5 4,259 2002 15,632 218 15,850 5,677 10,173 1,479 8,694 169 7,721 387 11,306 6 4,885 1,088 218 3,579 3,579 3,579 19 3,560
$
$
4.70 4.72
4.13 4.27
3.87 3.87
3.20 3.21
2.62 2.62
$
$
4.61 4.63 2.14 1,651 1,681 54,263 36.61 59.85 51.09 56.95 12.30 X 156 % 707,121 138,594
4.05 4.19 1.94 1,556 1,585 47,019 30.55 56.01 46.49 52.86 12.62 173 520,755 48,971
3.81 3.81 1.66 1,346 1,370 35,295 29.79 54.52 43.56 52.60 13.81 177 493,324 46,759
3.17 3.18 1.25 1,325 1,340 32,135 24.71 46.59 32.72 46.59 14.65 189 401,188 36,730
2.60 2.60 1.00 1,356 1,369 30,384 23.63 39.50 28.75 36.44 14.02 154 342,033 39,662
$
$ $
Wachovia Corporation 2006 Annual Report
47
Financial Tables
Table 4 NET TRADING REVENUE - INVESTMENT BANKING (a) Years Ended December 31, (In millions) Net interest income (Tax-equivalent) Trading accounts profits Other fee income Total net trading revenue (Tax-equivalent) $ 2006 235 524 302 1,061 2005 453 220 264 937 2004 557 108 288 953
$
(a) Certain amounts presented in prior years have been reclassified to conform to the presentation in 2006.
Table 5 SELECTED RATIOS Years Ended December 31, 2006 PERFORMANCE RATIOS (a) Assets to stockholders' equity Return on assets Return on common stockholders' equity Return on total stockholders' equity DIVIDEND PAYOUT RATIOS Common shares Preferred and common shares (a) Based on average balances and net income. 10.69 X 1.34 % 14.36 14.36 % 46.22 % 46.22 % 2005 10.83 1.31 14.13 14.13 46.30 46.30 2004 12.09 1.22 14.77 14.77 43.57 43.57 2003 11.25 1.18 13.25 13.27 39.31 39.15 2002 10.55 1.12 11.72 11.78 38.46 38.72
48
Wachovia Corporation 2006 Annual Report
Table 6 SELECTED QUARTERLY DATA 2006 (In millions, except per share data) Interest income Interest expense Net interest income Provision for credit losses Net interest income after provision for credit losses Securities gains (losses) Fee and other income Merger-related and restructuring expenses Other noninterest expense Minority interest in income of consolidated subsidiaries Income from continuing operations before income taxes Income taxes Income from continuing operations Discontinued operations, net of income taxes Net income $ PER COMMON SHARE DATA Basic earnings Income from continuing operations Net income Diluted earnings Income from continuing operations Net income Cash dividends Common stock price High Low Period-end SELECTED RATIOS (a) Return on assets Return on total stockholders' equity Stockholders' equity to assets $ 2005
Fourth 10,370 5,793 4,577 206 4,371 47 3,933 49 4,882 125 3,295 1,040 2,255 46 2,301
Third 7,784 4,243 3,541 108 3,433 94 3,371 38 4,007 104 2,749 872 1,877 1,877
Second 7,404 3,763 3,641 59 3,582 25 3,558 24 4,237 90 2,814 929 1,885 1,885
First 6,707 3,217 3,490 61 3,429 (48) 3,565 68 4,171 95 2,612 884 1,728 1,728
Fourth 6,490 2,967 3,523 81 3,442 (74) 3,063 58 4,125 103 2,145 652 1,493 214 1,707
Third 6,044 2,657 3,387 82 3,305 29 3,229 83 3,921 104 2,455 790 1,665 1,665
Second 5,702 2,344 3,358 50 3,308 136 2,841 90 3,698 71 2,426 776 1,650 1,650
First 5,453 2,040 3,413 36 3,377 (2) 2,997 61 3,811 64 2,436 815 1,621 1,621
$
1.20 1.22
1.19 1.19
1.19 1.19
1.11 1.11
0.97 1.11
1.07 1.07
1.05 1.05
1.03 1.03
1.18 1.20 0.56 57.49 53.37 56.95 1.31 % 13.09 9.98 %
1.17 1.17 0.56 56.67 52.40 55.80 1.34 14.85 9.03
1.17 1.17 0.51 59.85 52.03 54.08 1.39 15.41 9.03
1.09 1.09 0.51 57.69 51.09 56.05 1.34 14.62 9.18
0.95 1.09 0.51 55.13 46.49 52.86 1.30 14.60 8.92
1.06 1.06 0.51 51.34 47.23 47.59 1.29 13.95 9.25
1.04 1.04 0.46 53.07 49.52 49.60 1.31 14.04 9.36
1.01 1.01 0.46 56.01 49.91 50.91 1.31 13.92 9.44
$
(a) Based on average balances and net income.
Wachovia Corporation 2006 Annual Report
49
Financial Tables
Table 7 LOANS - ON-BALANCE SHEET, AND MANAGED AND SERVICING PORTFOLIOS December 31, (In millions) ON-BALANCE SHEET LOAN PORTFOLIO COMMERCIAL Commercial, financial and agricultural Real estate - construction and other Real estate - mortgage Lease financing Foreign Total commercial CONSUMER Real estate secured Student loans Installment loans Total consumer Total loans Unearned income Loans, net (On-balance sheet) MANAGED PORTFOLIO (a) COMMERCIAL On-balance sheet loan portfolio Securitized loans - off-balance sheet Loans held for sale Total commercial CONSUMER Real estate secured On-balance sheet loan portfolio Securitized loans - off-balance sheet Securitized loans included in securities Loans held for sale Total real estate secured Student On-balance sheet loan portfolio Securitized loans - off-balance sheet Securitized loans included in securities Loans held for sale Total student Installment On-balance sheet loan portfolio Securitized loans - off-balance sheet Securitized loans included in securities Loans held for sale Total installment Total consumer Total managed portfolio SERVICING PORTFOLIO (b) Commercial Consumer $ $ 171,298 194 8,866 180,358 156,854 1,227 3,860 161,941 141,226 1,734 2,112 145,072 107,466 2,001 2,574 112,041 109,097 2,218 1,140 112,455 2006 2005 2004 2003 2002
$
96,285 16,182 20,026 25,341 13,464 171,298 225,826 7,768 22,660 256,254 427,552 (7,394)
87,327 13,972 19,966 25,368 10,221 156,854 94,748 9,922 6,751 111,421 268,275 (9,260) 259,015
75,095 12,673 20,742 25,000 7,716 141,226 74,161 10,468 7,684 92,313 233,539 (9,699) 223,840
55,453 5,969 15,186 23,978 6,880 107,466 50,726 8,435 8,965 68,126 175,592 (10,021) 165,571
57,728 4,542 17,735 22,667 6,425 109,097 46,706 6,921 10,249 63,876 172,973 (9,876) 163,097
$
420,158
225,826 5,611 6,440 3,420 241,297 7,768 3,128 52 10,948 22,660 3,276 137 282 26,355 278,600 458,958
94,748 8,438 4,817 2,296 110,299 9,922 2,000 52 11,974 6,751 3,392 206 249 10,598 132,871 294,812
74,161 7,570 4,838 10,452 97,021 10,468 463 128 11,059 7,684 2,184 195 296 10,359 118,439 263,511
50,726 8,897 10,905 9,618 80,146 8,435 1,658 433 10,526 8,965 8,965 99,637 211,678
46,706 11,236 17,316 4,254 79,512 6,921 2,306 618 9,845 10,249 10,249 99,606 212,061
$ $
250,652 21,039
173,428 56,741
136,578 38,442
85,693 13,279
59,336 2,272
(a) The managed portfolio includes the on-balance sheet loan portfolio, loans securitized for which the retained interests are classified in securities on-balance sheet, loans held for sale on-balance sheet and the off-balance sheet portfolio of securitized loans sold, where we service the loans. (b) The servicing portfolio consists of third party commercial and consumer loans for which our sole function is that of servicing the loans for the third parties.
50
Wachovia Corporation 2006 Annual Report
Table 8 LOANS HELD FOR SALE Years Ended December 31, (In millions) Core business activity, beginning of year (a) Balance of acquired entities at purchase date Originations and/or purchases Transfer from loans held for sale, net Lower of cost or market value adjustments Performing loans sold or securitized Nonperforming loans sold Other, principally payments Core business activity, end of year Portfolio management activity, end of year (a) Total loans held for sale (b) $ 2006 6,388 193 62,085 (335) (54,827) (938) 12,566 2 12,568 2005 12,293 873 47,130 (12,743) (32,156) (9,009) 6,388 17 6,405 2004 12,504 653 38,192 (9,374) (2) (20,824) (2) (8,854) 12,293 695 12,988 2003 5,488 35,831 (806) (67) (24,399) (47) (3,496) 12,504 121 12,625 2002 6,991 27,443 (3,800) (52) (23,755) (11) (1,328) 5,488 524 6,012
$
(a) Core business activity means we originate and/or purchase loans with the intent to sell them to third parties, and portfolio management activity means we look for market opportunities to reduce risk in the loan portfolio by transferring loans to loans held for sale. (b) Nonperforming loans included in loans held for sale at December 31, 2006, 2005, 2004, 2003 and 2002, were $16 million, $32 million, $157 million, $82 million and $138 million, respectively.
Table 9 COMMERCIAL LOAN MATURITIES AND SENSITIVITY TO CHANGES IN INTEREST RATES (a) December 31, 2006 Real EstateConstruction and Other 50 148 100 298 7,671 7,874 339 15,884 16,182
(In millions) FIXED RATE 1 year or less 1-5 years After 5 years Total fixed rate ADJUSTABLE RATE 1 year or less 1-5 years After 5 years Total adjustable rate Total (a) Excludes lease financing. $ $
Commercial, Financial and Agricultural 2,403 6,406 8,399 17,208 25,938 40,030 13,109 79,077 96,285
Real EstateMortgage 240 1,307 795 2,342 5,867 9,631 2,186 17,684 20,026
Foreign 6,124 231 53 6,408 5,120 1,824 112 7,056 13,464
Total 8,817 8,092 9,347 26,256 44,596 59,359 15,746 119,701 145,957
Wachovia Corporation 2006 Annual Report
51
Financial Tables
Table 10 ALLOWANCE FOR LOAN LOSSES AND NONPERFORMING ASSETS Years Ended December 31, (In millions) ALLOWANCE FOR LOAN LOSSES (a) Balance, beginning of year Provision for credit losses Provision for credit losses relating to loans transferred to loans held for sale or sold Balance of acquired entities at purchase date Allowance relating to loans acquired, transferred to loans held for sale or sold Net charge-offs Balance, end of year as % of loans, net as % of nonaccrual and restructured loans (b) as % of nonperforming assets (b) LOAN LOSSES Commercial, financial and agricultural Commercial real estate - construction and mortgage Consumer Total loan losses LOAN RECOVERIES Commercial, financial and agricultural Commercial real estate - construction and mortgage Consumer Total loan recoveries Net charge-offs Commercial loan net charge-offs as % of average commercial loans, net Consumer loan net charge-offs as % of average consumer loans, net Total net charge-offs as % of average loans, net NONPERFORMING ASSETS Nonaccrual loans Commercial, financial and agricultural Commercial real estate - construction and mortgage Consumer real estate secured Installment loans Total nonaccrual loans Foreclosed properties (c) Total nonperforming assets Nonperforming loans included in loans held for sale Nonperforming assets included in loans and in loans held for sale as % of loans, net, and foreclosed properties (b) as % of loans, net, foreclosed properties and loans held for sale (d) Accruing loans past due 90 days $ $ $ $ 2006 2,724 430 8 603 (39) (366) 3,360 0.80 % 272 % 246 % 116 22 503 641 111 3 161 275 366 0.02 % 0.21 0.12 % 2005 2,757 227 18 (71) (207) 2,724 1.05 439 378 156 22 278 456 136 6 107 249 207 0.03 0.18 0.09 2004 2,348 290 (31) 510 (60) (300) 2,757 1.23 289 251 221 9 296 526 148 3 75 226 300 0.08 0.30 0.17 2003 2,604 549 75 (228) (652) 2,348 1.42 227 205 471 18 396 885 148 4 81 233 652 0.37 0.47 0.41 2002 2,813 1,110 357 (554) (1,122) 2,604 1.60 164 150 890 22 377 1,289 93 2 72 167 1,122 0.84 0.54 0.73
$
$
226 93 900 15 1,234 132 1,366 16 1,382 0.32 % 0.32 % 650
307 85 221 7 620 100 720 32 752 0.28 0.28 625
585 127 230 13 955 145 1,100 157 1,257 0.49 0.53 522
765 54 192 24 1,035 111 1,146 82 1,228 0.69 0.69 341
1,269 105 208 3 1,585 150 1,735 138 1,873 1.06 1.11 304
$ $ $
(a) See Note 7 in "Notes to Consolidated Financial Statements" for information related to the reserve for unfunded lending commitments. (b) These ratios do not include nonperforming loans included in loans held for sale. (c) Restructured loans are not significant. (d) These ratios reflect nonperforming loans included in loans held for sale. Loans held for sale are recorded at the lower of cost or market value, and accordingly, the amounts shown and included in the ratios are net of the transferred allowance for loan losses and the lower of cost or market value adjustments.
52
Wachovia Corporation 2006 Annual Report
Table 11 ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES December 31, 2006 Loans % of Total Loans 2005 Loans % of Total Loans 2004 Loans % of Total Loans 2003 Loans % of Total Loans 2002 Loans % of Total Loans
(In millions) COMMERCIAL Commercial, financial and agricultural Real estate Construction and other Mortgage Lease financing Foreign CONSUMER Real estate secured Student loans Installment loans UNALLOCATED Total
Amt.
Amt.
Amt.
Amt.
Amt.
$
1,423
22 % $
1,348
33 % $
1,384
32 % $
582
32 % $
864
33 %
157 206 41 40 497 16 820 160 3,360
4 5 6 3 53 2 5 100 % $
141 273 39 58 305 91 334 135 2,724
5 7 9 4 35 4 3 100 % $
155 268 35 67 382 56 320 90 2,757
5 9 11 3 32 5 3 100 % $
59 113 57 64 221 39 156 1,057 2,348
3 8 14 4 29 5 5 100 % $
75 128 66 77 196 4 192 1,002 2,604
3 10 13 4 27 4 6 100 %
$
Wachovia Corporation 2006 Annual Report
53
Financial Tables
Table 12 NONACCRUAL LOAN ACTIVITY (a) Years Ended December 31, (In millions) Balance, beginning of year COMMERCIAL NONACCRUAL LOAN ACTIVITY Commercial nonaccrual loans, beginning of year Balance of acquired entities at purchase date New nonaccrual loans and advances Gross charge-offs Transfers to loans held for sale Transfers to other real estate owned Sales Other, principally payments Net commercial nonaccrual loan activity Commercial nonaccrual loans, end of year CONSUMER NONACCRUAL LOAN ACTIVITY Consumer nonaccrual loans, beginning of year Balance of acquired entities at purchase date New nonaccrual loans and advances, net Transfers from (to) loans held for sale Sales and securitizations Net consumer nonaccrual loan activity Consumer nonaccrual loans, end of year Balance, end of year $ $ 2006 620 392 621 (138) (4) (158) (394) (73) 319 228 589 98 98 915 1,234 2005 955 712 751 (178) (25) (27) (313) (528) (320) 392 243 (29) 15 (1) (15) 228 620 2004 1,035 819 321 575 (230) (134) (3) (135) (501) (428) 712 216 21 10 (4) 6 243 955 2003 1,585 1,374 1,051 (489) (69) (12) (256) (780) (555) 819 211 106 (58) (43) 5 216 1,035 2002 1,534 1,381 2,275 (912) (239) (12) (278) (841) (7) 1,374 153 178 (58) (62) 58 211 1,585
(a) Excludes nonaccrual loans included in loans held for sale and foreclosed properties.
54
Wachovia Corporation 2006 Annual Report
Table 13 GOODWILL AND OTHER INTANGIBLE ASSETS December 31, (In millions) Goodwill Deposit base Customer relationships Tradename Total goodwill and other intangible assets $ 2006 38,379 883 662 90 40,014 2005 21,807 705 413 90 23,015 2004 21,526 1,048 443 90 23,107 2003 11,149 757 396 90 12,392 2002 10,880 1,225 239 90 12,434
$
Years Ended December 31, 2006, 2005 and 2004 Employee Termination Benefits Occupancy and Equipment
(In millions) EXIT COST PURCHASE ACCOUNTING ACCRUAL ACTIVITY Wachovia/Golden West - October 1, 2006 Purchase accounting adjustments Cash payments Balance, December 31, 2006 EXIT COST PURCHASE ACCOUNTING ACCRUAL ACTIVITY Wachovia/Westcorp - March 1, 2006 Purchase accounting adjustments Cash payments Balance, December 31, 2006 EXIT COST PURCHASE ACCOUNTING ACCRUAL ACTIVITY Wachovia/SouthTrust - November 1, 2004 Purchase accounting adjustments Cash payments Balance, December 31, 2004 Purchase accounting adjustments Cash payments Noncash write-downs Balance, December 31, 2005 Cash payments Noncash write-downs Balance, December 31, 2006
Other
Total
$ $
11 11
-
30 (29) 1
41 (29) 12
$ $
5 (3) 2
-
12 (12) -
17 (15) 2
$
168 (1) 167 54 (98) 123 (72) 51
62 (27) (26) 9 (3) (6) -
21 (17) 4 33 (34) 3 (1) 2
189 (18) 171 149 (159) (26) 135 (76) (6) 53
$
Wachovia Corporation 2006 Annual Report
55
Financial Tables
Table 14 DEPOSITS December 31, (In millions) CORE DEPOSITS Noninterest-bearing Savings and NOW accounts Money market accounts Other consumer time Total core deposits OTHER DEPOSITS Foreign Other time Total deposits $ 2006 66,572 86,106 105,428 113,665 371,771 21,988 13,699 407,458 2005 67,487 81,536 100,220 44,319 293,562 18,041 13,291 324,894 2004 64,197 83,678 91,184 35,529 274,588 9,881 10,584 295,053 2003 48,683 63,011 65,045 27,921 204,660 9,151 7,414 221,225 2002 44,640 51,691 45,649 33,763 175,743 6,608 9,167 191,518
$
Table 15 TIME DEPOSITS IN AMOUNTS OF $100,000 OR MORE December 31, (In millions) MATURITY OF 3 months or less Over 3 months through 6 months Over 6 months through 12 months Over 12 months Total time deposits in amounts of $100,000 or more $ 2006 16,800 16,331 11,597 4,593 49,321
$
56
Wachovia Corporation 2006 Annual Report
Table 16 RATES AND AMOUNTS OF SAVINGS BANK DEPOSITS (a) December 31, 2006 (In millions) Deposits Interest-bearing checking accounts Savings accounts Term certificate accounts with original maturities of 4 weeks to 1 year 1 to 2 years 2 to 3 years 3 to 4 years 4 years and over Retail jumbo certificates of deposits Total Rate 1.60 % $ 3.12 5.27 4.95 3.87 3.49 4.34 0.76 4.69 % $ Amount 3,844 9,287 44,988 7,969 573 551 1,988 12 69,212
(a) The weighted average rates and amounts of deposits are for World Savings Bank, FSB at December 31, 2006. These rates and amounts represent actual product rates and amounts and do not include purchase accounting or other adjustments.
Wachovia Corporation 2006 Annual Report
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Financial Tables
Table 17 CAPITAL RATIOS December 31, (In millions) CONSOLIDATED CAPITAL RATIOS (a) Qualifying capital Tier 1 capital Total capital Adjusted risk-weighted assets Adjusted leverage ratio assets Ratios Tier 1 capital Total capital Leverage STOCKHOLDERS' EQUITY TO ASSETS Year-end Average BANK CAPITAL RATIOS Tier 1 capital Wachovia Bank, National Association Wachovia Bank of Delaware, National Association World Savings Bank, FSB (b) Total capital Wachovia Bank, National Association Wachovia Bank of Delaware, National Association World Savings Bank, FSB (b) Leverage Wachovia Bank, National Association Wachovia Bank of Delaware, National Association World Savings Bank, FSB (b) 2006 2005 2004 2003 2002
$
$
39,428 60,194 531,303 656,428 7.42 % 11.33 6.01 9.86 9.35 %
30,308 43,709 404,068 495,601 7.50 10.82 6.12 9.13 9.24
28,583 39,633 356,766 448,205 8.01 11.11 6.38 9.59 8.27
23,863 32,307 279,979 375,447 8.52 11.54 6.36 8.09 8.89
21,411 30,732 260,609 316,473 8.22 11.79 6.77 9.38 9.49
7.58 % 16.27 13.77 11.08 17.84 14.16 6.66 11.18 7.30 %
7.45 14.07 10.70 16.27 6.26 10.52 -
7.86 15.76 11.52 18.28 6.15 12.18 -
7.60 15.46 11.72 18.28 5.85 9.72 -
7.42 14.35 11.81 16.58 6.25 11.04 -
(a) Risk-based capital ratio guidelines require a minimum ratio of tier 1 capital to risk-weighted assets of 4.00 percent and a minimum ratio of total capital to risk-weighted assets of 8.00 percent. The minimum leverage ratio of tier 1 capital to adjusted average quarterly assets is from 3.00 percent to 4.00 percent. (b) World Savings Bank, FSB is an affiliate of Golden West.
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Wachovia Corporation 2006 Annual Report
Table 18 INTEREST DIFFERENTIAL 2006 Compared with 2005 Interest Income/ Expense Variance $ 63 115 (53) 440 8,596 (167) (54) 8,940 (428) $ 8,512 4,094 383 2,472 6,949 59 7,008 1,504 Interest Income/ Expense Variance 30 453 429 962 4,676 135 167 6,852 (482) 6,370 2,649 1,328 544 4,521 160 4,681 1,689 2005 Compared with 2004
(In millions) EARNING ASSETS Interest-bearing bank balances Federal funds sold and securities purchased under resale agreements Trading account assets (a) Securities (a) Loans (a) Loans held for sale Other earning assets Total earning assets excluding derivatives Risk management derivatives Total earning assets including derivatives INTEREST-BEARING LIABILITIES Deposits Short-term borrowings Long-term debt Total interest-bearing liabilities excluding derivatives Risk management derivatives Total interest-bearing liabilities including derivatives Net interest income
Variance Attributable to (b) Rate Volume 51 322 160 279 3,494 137 178 4,621 (428) 4,193 3,131 898 552 4,581 59 4,640 (447) 12 (207) (213) 161 5,102 (304) (232) 4,319 4,319 963 (515) 1,920 2,368 2,368 1,951
Variance Attributable to (b) Rate Volume 55 475 205 252 1,706 208 215 3,116 (482) 2,634 1,931 1,176 206 3,313 160 3,473 (839) (25) (22) 224 710 2,970 (73) (48) 3,736 3,736 718 152 338 1,208 1,208 2,528
$
(a) Yields related to securities and loans exempt from federal and state income taxes are stated on a fully tax-equivalent basis. They are reduced by the nondeductible portion of interest expense, assuming a federal tax rate of 35 percent and applicable state tax rates. Lease financing amounts include related deferred income taxes. (b) Changes attributable to rate/volume are allocated to both rate and volume on an equal basis.
Wachovia Corporation 2006 Annual Report
59
Financial Tables
WACHOVIA CORPORATION AND SUBSIDIARIES NET INTEREST INCOME SUMMARIES YEAR ENDED 2006 Average Rates Earned/ Paid 5.16 % 4.82 5.44 5.38 $ YEAR ENDED 2005 Average Rates Earned/ Paid 3.23 % 3.31 4.94 5.14
(In millions) ASSETS Interest-bearing bank balances Federal funds sold and securities purchased under resale agreements Trading account assets (a) (c) Securities (a) (c) Loans (a) (b) (c) Commercial Commercial, financial and agricultural Real estate - construction and other Real estate - mortgage Lease financing Foreign Total commercial Consumer Real estate secured Student loans Installment loans Total consumer Total loans Loans held for sale Other earning assets Total earning assets excluding derivatives Risk management derivatives (d) Total earning assets including derivatives Cash and due from banks Other assets Total assets LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing deposits Savings and NOW accounts Money market accounts Other consumer time Foreign Other time Total interest-bearing deposits Federal funds purchased and securities sold under repurchase agreements Commercial paper Securities sold short Other short-term borrowings Long-term debt Total interest-bearing liabilities excluding derivatives Risk management derivatives (d) Total interest-bearing liabilities including derivatives Noninterest-bearing deposits Other liabilities Stockholders' equity Total liabilities and stockholders' equity Interest income and rate earned - including derivatives Interest expense and equivalent rate paid - including derivatives Net interest income and margin - including derivatives (d) $ $ $
Average Balances 2,793 18,911 29,695 118,170
Interest Income/ Expense 144 910 1,615 6,353
Average Balances 2,516 24,008 33,800 115,107
Interest Income/ Expense 81 795 1,668 5,913
92,100 15,259 19,904 9,836 11,360 148,459 130,275 9,975 19,013 159,263 307,722 10,428 6,343 494,062 494,062 12,300 73,972 580,334
6,365 1,139 1,477 684 588 10,253 9,008 633 1,787 11,428 21,681 707 479 31,889 531 32,420
6.91 7.46 7.42 6.95 5.18 6.91 6.91 6.35 9.40 7.18 7.05 6.78 7.54 6.45 0.11 6.56
80,901 13,158 20,187 10,223 8,035 132,504 77,152 11,126 7,140 95,418 227,922 15,293 9,944 428,590 428,590 12,524 67,896 $ 509,010
4,554 760 1,194 727 303 7,538 4,511 548 488 5,547 13,085 874 533 22,949 959 23,908
5.63 5.78 5.92 7.12 3.77 5.69 5.85 4.92 6.84 5.81 5.74 5.71 5.36 5.35 0.23 5.58
79,194 100,824 64,872 20,305 13,949 279,144 48,457 4,775 9,168 6,431 87,178 435,153 435,153 64,136 26,782 54,263 580,334 $ $
1,389 3,209 2,730 906 707 8,941 2,212 215 313 144 4,605 16,430 586 17,016
1.75 3.18 4.21 4.46 5.07 3.20 4.56 4.50 3.41 2.26 5.28 3.78 0.13 3.91
79,762 96,826 39,695 13,922 11,947 242,152 54,302 11,898 10,279 6,675 47,774 373,080 373,080 62,438 26,473 47,019 $ 509,010 $ $
833 1,950 1,206 422 436 4,847 1,673 363 341 124 2,133 9,481 527 10,008
1.04 2.01 3.04 3.03 3.66 2.00 3.08 3.05 3.31 1.87 4.46 2.54 0.14 2.68
32,420 17,016 15,404
6.56 % 3.44 3.12 %
23,908 10,008 13,900
5.58 % 2.34 3.24 %
(a) Yields related to securities and loans exempt federal and state income taxes are stated on stated on a fully tax-equivalent basis. They are reduced by (a) Yields related to securities and loans exempt from from federal and state income taxes are a fully tax-equivalent basis. They are reduced by the the nondeductible portion of interest expense, assuming a rate of tax rate of 35 percent and applicable state tax rates. Lease include related deferred nondeductible portion of interest expense, assuming a federal taxfederal 35 percent and applicable state tax rates. Lease financing amounts financing amounts include related deferred income taxes. (b) net loan averages are and the averages include income, and the accrual of interest loans on which the income taxes. (b) The loan averages are stated Theof unearned income, stated net of unearned loans on which theaverages include has been discontinued. accrual of interest has been discontinued.
60
Wachovia Corporation 2006 Annual Report
YEAR ENDED 2004 Average Rates Earned/ Paid 1.43 % 1.37 4.28 4.90 $
YEAR ENDED 2003 Average Rates Earned/ Paid 1.31 % 1.02 4.43 5.27 $
YEAR ENDED 2002 Average Rates Earned/ Paid 1.90 % 1.83 5.20 6.32
Average Balances $ 3,578 24,940 28,944 100,960
Interest Income/ Expense 51 342 1,239 4,951
Average Balances 3,836 16,780 18,395 78,593
Interest Income/ Expense 50 172 814 4,143
Average Balances 3,312 10,702 14,774 62,142
Interest Income/ Expense 63 195 769 3,924
59,970 7,395 16,050 8,467 7,144 99,026 54,928 9,891 8,188 73,007 172,033 16,735 11,064 358,254 358,254 11,311 57,202 $ 426,767
2,653 296 725 721 187 4,582 2,981 372 474 3,827 8,409 739 366 16,097 1,441 17,538
4.43 4.00 4.52 8.51 2.61 4.63 5.43 3.76 5.79 5.24 4.89 4.42 3.30 4.49 0.41 4.90
56,404 5,393 16,388 6,915 6,652 91,752 48,894 7,919 9,762 66,575 158,327 9,110 7,199 292,240 292,240 10,888 58,373 $ 361,501
2,390 190 720 739 189 4,228 2,824 305 630 3,759 7,987 395 243 13,804 1,532 15,336
4.24 3.52 4.39 10.69 2.84 4.61 5.78 3.85 6.45 5.65 5.04 4.34 3.38 4.72 0.53 5.25
59,724 5,305 18,365 7,235 6,875 97,504 41,971 3,916 11,061 56,948 154,452 7,401 3,388 256,171 256,171 10,313 54,119 $ 320,603
2,858 217 942 762 239 5,018 2,884 183 829 3,896 8,914 375 178 14,418 1,432 15,850
4.78 4.10 5.13 10.54 3.48 5.15 6.87 4.66 7.50 6.84 5.77 5.06 5.25 5.63 0.56 6.19
72,078 79,526 28,304 7,933 8,301 196,142 47,321 12,034 11,025 6,087 39,780 312,389 312,389 51,700 27,383 35,295 $ 426,767 $ $
369 794 757 115 163 2,198 637 163 318 55 1,589 4,960 367 5,327
0.51 1.00 2.67 1.45 1.98 1.12 1.35 1.35 2.88 0.90 4.00 1.59 0.12 1.71
53,117 55,816 30,553 8,101 7,700 155,287 44,326 7,196 7,925 5,166 36,676 256,576 256,576 43,636 29,154 32,135 $ 361,501 $ $
260 565 923 104 143 1,995 525 72 209 40 1,476 4,317 156 4,473
0.49 1.01 3.02 1.28 1.86 1.28 1.19 1.00 2.64 0.77 4.02 1.68 0.06 1.74
49,091 41,711 36,492 7,323 7,285 141,902 32,242 3,063 6,322 2,630 38,902 225,061 225,061 38,972 26,178 30,392 $ 320,603 $ $
464 657 1,442 131 153 2,847 558 34 155 27 1,667 5,288 389 5,677
0.95 1.57 3.95 1.78 2.10 2.01 1.73 1.10 2.45 1.04 4.29 2.35 0.17 2.52
17,538 5,327 12,211
4.90 % 1.49 3.41 %
15,336 4,473 10,863
5.25 % 1.53 3.72 %
15,850 5,677 10,173
6.19 % 2.22 3.97 %
(c) Tax-equivalent adjustments included in trading account assets, securities, commercial, financial and agricultural loans, and lease financing are (in millions): $40, $74, $38 and $3, respectively, in 2006; $87, $89, $38 and $5, respectively, in 2005; and $92, $113, $40 and $5, respectively, in 2004. (d) The rates earned and the rates paid on risk management derivatives are based on off-balance sheet notional amounts. The fair value of these instruments is included in other assets and other liabilities.
Wachovia Corporation 2006 Annual Report
61
Management’s Report
WACHOVIA CORPORATION AND SUBSIDIARIES MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of Wachovia Corporation and subsidiaries (the "Company") is responsible for establishing and maintaining effective internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Under the supervision and with the participation of management, including the principal executive officer and principal financial officer, the Company conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation under the framework in Internal Control – Integrated Framework, management of the Company has concluded the Company maintained effective internal control over financial reporting, as such term is defined in Securities Exchange Act of 1934 Rules 13a-15(f), as of December 31, 2006. Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting can also be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk. Management is also responsible for the preparation and fair presentation of the consolidated financial statements and other financial information contained in this report. The accompanying consolidated financial statements were prepared in conformity with U.S. generally accepted accounting principles and include, as necessary, best estimates and judgments by management. KPMG LLP, an independent, registered public accounting firm, has audited the Company’s consolidated financial statements as of and for the year ended December 31, 2006, and the Company’s assertion as to the effectiveness of internal control over financial reporting as of December 31, 2006, as stated in their reports, which are included herein.
G. Kennedy Thompson Chairman, President and Chief Executive Officer February 23, 2007
Thomas J. Wurtz Senior Executive Vice President and Chief Financial Officer
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Wachovia Corporation 2006 Annual Report
Independent Auditors’ Report
WACHOVIA CORPORATION AND SUBSIDIARIES REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders Wachovia Corporation We have audited management's assessment, included in the accompanying Wachovia Corporation and Subsidiaries: Management’s Report on Internal Control over Financial Reporting, that Wachovia Corporation maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO"). Wachovia Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management's assessment that Wachovia Corporation maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO"). Also, in our opinion, Wachovia Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO"). We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Wachovia Corporation and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2006, and our report dated February 23, 2007, expressed an unqualified opinion on those consolidated financial statements.
Charlotte, North Carolina February 23, 2007
Wachovia Corporation 2006 Annual Report
63
Independent Auditors’ Report
WACHOVIA CORPORATION AND SUBSIDIARIES REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders Wachovia Corporation We have audited the accompanying consolidated balance sheets of Wachovia Corporation and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2006. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Wachovia Corporation and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles. As discussed in Note 1 to the consolidated financial statements, Wachovia Corporation changed its method of accounting for mortgage servicing rights, stock-based compensation and pension and other postretirement plans in 2006. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Wachovia Corporation’s internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO"), and our report dated February 23, 2007, expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.
Charlotte, North Carolina February 23, 2007
64
Wachovia Corporation 2006 Annual Report
Audited Financial Statements
WACHOVIA CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, (In millions, except per share data) ASSETS Cash and due from banks Interest-bearing bank balances Federal funds sold and securities purchased under resale agreements Total cash and cash equivalents Trading account assets Securities (amortized cost $109,589 in 2006; $114,213 in 2005) Loans, net of unearned income ($7,394 in 2006; $9,260 in 2005) Allowance for loan losses Loans, net Loans held for sale Premises and equipment Due from customers on acceptances Goodwill Other intangible assets Other assets Total assets LIABILITIES AND STOCKHOLDERS' EQUITY Deposits Noninterest-bearing deposits Interest-bearing deposits Total deposits Short-term borrowings Bank acceptances outstanding Trading account liabilities Other liabilities Long-term debt Total liabilities Minority interest in net assets of consolidated subsidiaries STOCKHOLDERS' EQUITY Preferred stock, Class A, 40 million shares, no par value; 10 million shares, no par value; none issued Dividend Equalization Preferred shares, no par value, outstanding 97 million shares in 2006 and in 2005 Non-Cumulative Perpetual Class A Preferred Stock, Series I, $100,000 liquidation preference per share, 25,010 shares authorized Common stock, $3.33-1/3 par value; authorized 3 billion shares, outstanding 1.904 billion shares in 2006; 1.557 billion shares in 2005 Paid-in capital Retained earnings Accumulated other comprehensive income, net Total stockholders' equity Total liabilities and stockholders' equity See accompanying Notes to Consolidated Financial Statements. $ $ 2006 15,826 2,167 16,923 34,916 45,529 108,619 420,158 (3,360) 416,798 12,568 6,141 855 38,379 1,635 41,681 707,121 2005 15,072 2,638 19,915 37,625 42,704 113,698 259,015 (2,724) 256,291 6,405 4,910 824 21,807 1,208 35,283 520,755
$
66,572 340,886 407,458 49,157 863 18,228 20,004 138,594 634,304 3,101
67,487 257,407 324,894 61,953 892 17,598 15,986 48,971 470,294 2,900
6,347 51,746 13,723 (2,100) 69,716 707,121
5,189 31,172 11,973 (773) 47,561 520,755
Wachovia Corporation 2006 Annual Report
65
Audited Financial Statements
WACHOVIA CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, (In millions, except per share data) INTEREST INCOME Interest and fees on loans Interest and dividends on securities Trading account interest Other interest income Total interest income INTEREST EXPENSE Interest on deposits Interest on short-term borrowings Interest on long-term debt Total interest expense Net interest income Provision for credit losses Net interest income after provision for credit losses FEE AND OTHER INCOME Service charges Other banking fees Commissions Fiduciary and asset management fees Advisory, underwriting and other investment banking fees Trading account profits Principal investing Securities gains (losses) Other income Total fee and other income NONINTEREST EXPENSE Salaries and employee benefits Occupancy Equipment Advertising Communications and supplies Professional and consulting fees Other intangible amortization Merger-related and restructuring expenses Sundry expense Total noninterest expense Minority interest in income of consolidated subsidiaries Income from continuing operations before income taxes Income taxes Income from continuing operations Discontinued operations, net of income taxes Net income PER COMMON SHARE DATA Basic Income from continuing operations Net income Diluted Income from continuing operations Net income Cash dividends AVERAGE COMMON SHARES Basic Diluted See accompanying Notes to Consolidated Financial Statements. $ 2006 21,976 6,433 1,575 2,281 32,265 9,119 3,114 4,783 17,016 15,249 434 14,815 2,480 1,756 2,406 3,248 1,345 535 525 118 2,132 14,545 10,903 1,173 1,184 204 653 790 423 179 1,967 17,476 414 11,470 3,725 7,745 46 7,791 2005 13,970 5,783 1,581 2,355 23,689 5,297 2,777 1,934 10,008 13,681 249 13,432 2,151 1,491 2,343 3,011 1,109 286 401 89 1,338 12,219 9,671 1,064 1,087 193 633 662 416 292 1,829 15,847 342 9,462 3,033 6,429 214 6,643 2004 9,858 4,639 1,147 1,644 17,288 2,853 1,503 971 5,327 11,961 257 11,704 1,978 1,226 2,554 2,819 911 151 261 (10) 889 10,779 8,703 947 1,052 193 620 548 431 444 1,728 14,666 184 7,633 2,419 5,214 5,214
$
$
4.70 4.72 4.61 4.63 2.14 1,651 1,681
4.13 4.27 4.05 4.19 1.94 1,556 1,585
3.87 3.87 3.81 3.81 1.66 1,346 1,370
$
66
Wachovia Corporation 2006 Annual Report
WACHOVIA CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Years Ended December 31, 2006, 2005 and 2004 Accumulated Other Comprehensive Income, Net 1,339 (65)
(In millions, except per share data) Balance, December 31, 2003 Comprehensive income Net income Minimum pension liability Net unrealized losses, net of reclassification adjustments on Debt and equity securities Derivative financial instruments Total comprehensive income Purchases of common stock Common stock issued for Stock options and restricted stock Acquisitions Deferred income taxes on subsidiary stock Deferred compensation, net Dividends at $1.66 per common share Balance, December 31, 2004 Comprehensive income Net income Minimum pension liability Net unrealized losses, net of reclassification adjustments on Debt and equity securities Derivative financial instruments Total comprehensive income Purchases of common stock Common stock issued for Stock options and restricted stock Acquisitions Deferred compensation, net Dividends at $1.94 per common share Balance, December 31, 2005, as reported Cumulative effect of an accounting change, net of income taxes Balance, December 31, 2005 Comprehensive income Net income Minimum pension liability Net unrealized gains (losses), net of reclassification adjustments on Debt and equity securities Derivative financial instruments Total comprehensive income Adjustment to initially apply SFAS 158, net of income taxes Purchases of common stock Common stock issued for Stock options and restricted stock Acquisitions Deferred compensation, net Dividends at $2.14 per common share Balance, December 31, 2006
Common Stock Shares Amount 1,312 $ 4,374 -
Paid-in Capital 17,811 -
Retained Earnings 8,904 5,214 -
Total 32,428 5,214 (65)
(47) 25 298 1,588 -
(159) 85 994 5,294 -
(651) 890 13,006 64 31,120 -
5,214 (1,547) (87) (2,306) 10,178 6,643 -
(245) (304) (614) 725 (19)
(245) (304) 4,600 (2,357) 975 14,000 (87) 64 (2,306) 47,317 6,643 (19)
(52) 21 1,557 1,557 -
(173) 68 5,189 5,189 -
(711) 830 3 (70) 31,172 31,172 -
6,643 (1,809) (3,039) 11,973 41 12,014 7,791 -
(1,424) (55) (1,498) (773) (773) 29
(1,424) (55) 5,145 (2,693) 898 3 (70) (3,039) 47,561 41 47,602 7,791 29
(82) 25 404 1,904 $
(274) 83 1,349 6,347
(1,746) 1,037 21,098 185 51,746
7,791 (2,493) (3,589) 13,723
(293) 23 (241) (1,086) (2,100)
(293) 23 7,550 (1,086) (4,513) 1,120 22,447 185 (3,589) 69,716
See accompanying Notes to Consolidated Financial Statements.
Wachovia Corporation 2006 Annual Report
67
Audited Financial Statements
WACHOVIA CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, (In millions) OPERATING ACTIVITIES Net income Adjustments to reconcile net income to net cash provided (used) by operating activities Gain on sale of discontinued operations Accretion and amortization of securities discounts and premiums, net Provision for credit losses Gain on securitization transactions Gain on sale of mortgage servicing rights Securities transactions Depreciation and other amortization Deferred income taxes Trading account assets, net (Gain) loss on sales of premises and equipment Contribution to qualified pension plan Excess income tax benefits from share-based payment arrangements Loans held for sale, net Deferred interest on certain loans Other assets, net Trading account liabilities, net Other liabilities, net Net cash provided (used) by operating activities INVESTING ACTIVITIES Increase (decrease) in cash realized from Sales of securities Maturities of securities Purchases of securities Origination of loans, net Sales of premises and equipment Purchases of premises and equipment Goodwill and other intangible assets Divestiture of Corporate and Institutional Trust businesses Purchase of bank-owned separate account life insurance, net Cash equivalents acquired, net of purchases of banking organizations Net cash used by investing activities FINANCING ACTIVITIES Increase (decrease) in cash realized from Increase in deposits, net Securities sold under repurchase agreements and other short-term borrowings, net Issuances of long-term debt Payments of long-term debt Issuances of common stock, net Purchases of common stock Excess income tax benefits from share-based payment arrangements Cash dividends paid Net cash provided by financing activities Increase (decrease) in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year CASH PAID FOR Interest Income taxes NONCASH ITEMS Transfer to securities from loans resulting from securitizations Transfer to securities from loans held for sale resulting from securitizations Transfer to loans from securities resulting from terminated securitizations Transfer to loans held for sale from securities resulting from terminated securitizations Transfer to loans from loans held for sale Cumulative effect of an accounting change, net of income taxes Issuance of common stock for purchase accounting acquisitions See accompanying Notes to Consolidated Financial Statements. $ 2006 7,791 (46) (37) 434 (278) (29) (118) 1,686 530 (2,825) (1) (600) (152) (6,339) (362) (2,550) 630 4,209 1,943 2005 6,643 (214) 216 249 (210) (26) (89) 1,449 803 3,241 107 (330) (162) (5,527) 3,917 (4,111) (250) 5,706 2004 5,214 191 257 (113) (34) 10 1,415 (1,534) (11,071) 101 (279) (70) (4,356) 559 2,464 (608) (7,854)
31,595 18,848 (40,204) (25,512) 292 (1,756) (100) (2,544) (2,532) (21,913)
54,571 40,877 (101,001) (23,565) 2,155 (2,762) (501) 740 (1,791) 34 (31,243)
55,393 29,834 (89,110) (12,236) 580 (960) (471) (372) 1,110 (16,232)
13,268 (17,246) 42,429 (13,904) 664 (4,513) 152 (3,589) 17,261 (2,709) 37,625 34,916 16,379 2,471 2,422 60 335 41 22,447
29,841 (2,240) 10,486 (8,283) 337 (2,693) 162 (3,039) 24,571 (966) 38,591 37,625 9,629 3,032 931 212 12,636 -
36,727 (12,031) 8,495 (5,079) 646 (2,357) 70 (2,306) 24,165 79 38,512 38,591 5,207 3,954 213 980 3,918 8,558 14,000
$ $
$
68
Wachovia Corporation 2006 Annual Report
WACHOVIA CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2006, 2005 AND 2004 NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
GENERAL Wachovia Corporation (the "Parent Company") is a bank holding company whose principal wholly owned subsidiaries are Wachovia Bank, National Association ("Wachovia Bank"), a national banking association; World Savings Bank, FSB, a federallychartered savings bank; and Wachovia Capital Markets, LLC, an institutional and investment banking company. The Company also holds a 62 percent interest in Wachovia Securities Financial Holdings, LLC, the parent company of Wachovia Securities, LLC ("Wachovia Securities"), a retail brokerage company, as well as a majority interest in Wachovia Preferred Funding Corp., a Real Estate Investment Trust ("REIT"), which has publicly traded preferred stock outstanding. Wachovia Corporation and subsidiaries (together the "Company") is a diversified financial services company whose operations are principally domestic. The accounting and reporting policies of the Company are in accordance with U.S. generally accepted accounting principles, and they conform to general practices within the applicable industries. The consolidated financial statements include the accounts of the Parent Company and all its majority-owned subsidiaries as well as variable interest entities where the Company is the primary beneficiary. In consolidation, all significant intercompany accounts and transactions are eliminated. Management has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with U.S. generally accepted accounting principles. Actual results could differ from those estimates. CASH AND CASH EQUIVALENTS Cash and cash equivalents include cash and due from banks, interest-bearing bank balances and federal funds sold and securities purchased under resale agreements. Generally, cash and cash equivalents have maturities of three months or less, and accordingly, the carrying amount of these instruments is deemed to be a reasonable estimate of fair value. SECURITIES PURCHASED AND SOLD AGREEMENTS Securities purchased under resale agreements and securities sold under repurchase agreements are generally accounted for as collateralized financing transactions and are recorded at the amount at which the securities were acquired or sold plus accrued interest. It is the Company’s policy to take possession of securities purchased under resale agreements, which are primarily U.S. Government and Government agency securities. The Company monitors the market value of securities purchased and sold and obtains collateral from or returns it to counterparties when appropriate. SECURITIES AND TRADING ACTIVITIES S