Wells Fargo Financial Analysis Projection Report

MBA-520 9-1 Final Project: Wells Fargo Financial Analysis Projection Report Maham Ba Southern New Hampshire University  Executive Summary. This report presents the current financial performance and health analysis of Wells Fargo with emphasis on the company’s profitability, liquidity, solvency and managerial efficiency for the period 2015 – 2017. The report also includes analysis of business opportunities, success factors, risks, and financial statement projections for 2018 – 2020 along with sensitivity analysis of 2018 financial performance. Methods of analysis include common-size and trend analyses, as ratios such as ROA, ROE, turnover, and net margin among many others. Other calculations for gauging the company’s financial health include WACC, EV and market capitalization. All the calculations and financial projections can be found in the appendices. The data analyzed was collected from the company’s actual financial statements for the past several years, and the results indicate that the company is in a strong position compared to its closest competitors. Its performance in terms of profitability, liquidity, solvency and efficiency is above the industry average. The report finds that Wells Fargo’s future prospects are excellent and it can comfortably undertake emerging investment opportunities as the company has the resources to fuel future growth. It is recommended that the company invests $5.2 billion to acquire the MSRs of Navy Federal Credit Union to expand its assets base and consolidate its market leadership when it comes to mortgage servicing. Key limitations of the report include incorporation of assumptions in projecting future financial performance, inability to accurately forecast future economic conditions and use of past performance to create pro forma statements. Approach. This financial analysis of Wells Fargo primarily relied on the company’s SEC 10-K filings, information from the company’s website and other publicly available information from websites such as Yahoo! Finance, Marketwatch, Bloomberg and Morningstar among others. Consequently, the recommendations resulting from the analysis are purely based on my analysis of publicly available data and not confidential information provided by Wells Fargo’s management or any other source. Future performance projections such as the pro forma financial statements are based on trend and common-size analysis of the company’s actual financial statements for the past 5 years. However, the projections also incorporated my assumptions about the company and the financial services industry in general, so there is a possibility that these projections are not completely accurate. I recognize that the report may have limitations since the analyses do not include any confidential information from either Wells Fargo, Navy Federal or other sources. My recommendations are not based on proprietary information about how Wells Fargo conducts its business, thus using these recommendations to make business decisions carries some risk and may result in wrong decisions. For example, the recommended MSRs investment was arrived at using prevailing market rates for different categories of products for Wells Fargo or Navy Federal. However, the two companies’ mortgage products are not identical, so I was matching them to determine relevant rates based on product names. If I were to refine the report further I would consult the managements of both Wells Fargo and Navy credit especially with regard to the recommended investment in the latter’s MSRs. The first part of the analysis involved researching the company with a view to identifying its relevant industry, the services the company provides, its organizational structure, reporting segments and the countries and regions where it operates. This part of the analysis informed the risk analysis section of the report and assumptions about growth prospects when preparing pro forma financial statements. Having gathered preliminary information about the company, I moved on to the financial analysis segment where I began by collecting consolidated financial statements from the company’s SEC form 10-K for the period 2015 to 2017. The financial statements I collected were: (1) consolidated income statements; (2) consolidated balance sheets; and (3) consolidated cash flow statements which I used to perform trend analysis and ratio analysis to assess Wells Fargo’s recent performance. After analyzing Wells Fargo’s recent performance in terms of liquidity, profitability, managerial efficiency and solvency using the company’s actual financial statements from 2015 to 2017. I then collected further information about the company from websites including Trading Economics, Bloomberg, and Morningstar, and used this information to estimate the company’s financial value. I combined the information with primary data from Wells Fargo’s Form 10-K to calculate the company’s enterprise value and market capitalization. Additionally, I examined the company’s cash flow statements and balance sheet to determine whether it had resources to fuel future growth. Finally, I analyzed Wells Fargo’s success factors and risks prioritizing effects of financial and strategic priorities on the company’s accounting procedures and business decisions and how to better capitalize on non-financial factors, and then used actual financial statements trend analysis to project consolidate income statements and balance sheets for the period 2018 – 2020. Financial Performance Organizational Context Services Wells Fargo & Company (“Wells Fargo”, the “Company”) is a San Francisco, CA-based financial services multinational with operations in all 50 states, the District of Columbia and in other countries and territories around the world. The corporation is organized under the laws of Delaware, and is both a financial holding and bank holding company which in addition to the United States has operations in international markets such as India, the Philippines, Canada, the United Kingdom and China among others. As of December 2017, Wells Fargo was ranked among the largest banks in terms of total assets in the United States. The company had $1.95 trillion in total assets and was ranked third behind Bank of America Corporation with $2.28 trillion in total assets and JPMorgan Chase & Company with $2.53 trillion in total assets. As a diversified financial services multinational, Wells Fargo provides retail, commercial and corporate banking services. The company serves its individual business and institutional customers through its network of banking locations and offices as well as through the internet and other distribution channels. Additionally, Wells Fargo provides other financial services through subsidiaries engaged in various businesses. Some of the services the company provides through subsidiaries include wholesale banking, mortgage banking, consumer finance, equipment leasing, agricultural finance, and commercial finance. The company also provides securities brokerage and investment banking, computer and data processing services, trust services, investment advisory services, mortgage-backed securities servicing and venture capital investment (Wells Fargo, 2018). Company Organization and Management Wells Fargo has three operating segments for management reporting purposes. The company’s reporting segments are: (1) Community Banking; (2) Wholesale Banking; and (3) Wealth and Investment Management. The company defines its operating segments by product type and customer segment. However, results are based on the management accounting process, and do not follow any comprehensive, authoritative guidance. The management accounting process measures the performance of the operating segments based on the company’s management structure and is not necessarily comparable with similar information for other financial services companies. Additionally, Wells Fargo’s accounting and reporting policies conform with U.S. generally accepted accounting principles (GAAP) and practices in the financial services industry. Management of Wells Fargo prepares financial statements based on their estimates. These estimates are based on management assumptions about future economic and market conditions. Some of the factors that managers take into account when making estimates include unemployment, market liquidity and real estate process among other factors that affect the reported amounts of assets and liabilities at the date of the financial statements, income and expenses during the reporting period and the related disclosures (Wells Fargo, 2018). Management estimates contemplate current conditions and expected future changes, thus there is a possibility that the company’s results of operations and financial condition could be materially affected. Some of the areas where management makes significant estimates when preparing financial statements include: Allowance for credit loses Valuation of residential mortgages servicing rights Income taxes, and Liabilities for contingent litigation losses Recent Financial Performance Consolidated Income Statements 2015-2017 Analysis of Wells Fargo’s consolidated income statements for the last three years reveal that the company has achieved growth in terms of revenues, but its net income has slightly declined. Appendix 1 contains the company’s three-year consolidated income statements along with trend and common-size analysis. Interest income was 58.78%, 61.41% and 67.62% of total revenues in 2015, 2016 and 2017 respectively, so the company achieved consistent growth in terms of interest income. Trend analysis of interest income show that it improved from 8.90% in 2016 to 9.78% in 2017. However, non-interest income was 45.96%, 45.35%, and 43.12% of total revenues in 2015, 2016 and 2017 respectively whereas non-interest expense was 59.62%, 59.94%, and 67.13% of total revenues in 2015, 2016 and 2017 respectively. This shows that the bank incurred more costs to earn non-interest revenue and as a result its net income decreased by 4.18% in 2016 and 1.12% in 2017. Consolidated Cash Flow Statements 2015-2017 Appendix 2 presents a trend analysis of Wells Fargo’s consolidated cash flow statements for the past three financial years. There are a couple of things that stand out from the trend analysis of the company’s cash flow statements. Firstly, there was a sharp increase in expenditure on other operating activities followed by a sharp decrease. The company’s expenses on other operating activities increase by 116.04% in 2016 before falling by 61.47% in 2017. Secondly, there was a marginal increase in expenditure on investing activities in 2016 followed by a sharp decline in 2017. The company’s expenses on investing activities increased by 13.88% in 2016 before falling by 95.77% in 2017. Purchases of investments, and acquisitions and dispositions appear to have had the most impact on the company’s investing activities. Assessment of Underlying Financial Performance As highlighted in part b, above one of the things that stand out in the cash flow statement analysis is the acquisitions and dispositions part of the investing section of the cash flow statement which shows that the company spent $30,584. This line item stood out in the trend analysis of the previous three years cash flow statements because it had the biggest increase of any line item in 2016 and this was followed by a decrease of 98% in 2017 when the company spent only $320 million on mergers and acquisitions. In March 2016, Wells Fargo completed the purchase of the North American portions of GE Capital’s Commercial Distribution Finance and Vendor Finance businesses as well as a portion of its Corporate Finance business, totaling $27.4 billion of assets, including approximately $24 billion of loans. The total acquisition included assets of approximately $31 billion as well as businesses employing approximately 2,800 team members. Wells Fargo’s key profitability and managerial efficiency ratios show that the company’s performance has been relatively stable in the last three years and that the company is thriving in its industry. Profitability ratios assess the company’s ability to generate earnings compared to the resources it deploys, for example capital and assets invested over a given period of time. In comparison, efficiency ratios analyze how effectively the company converts resources it deploys into revenue generated. There were marginal declines in Wells Fargo’s ROA and ROE ratio between 2015 and 2016, but the company performed better than both of it biggest competitors, Bank of America and JP Morgan. Bank of America’s ROA in 2015, 2016 and 2017 was 0.68, 0.75 and 0.74 respectively compared to JP Morgan’s 0.91, 0.95 and 0.90 respectively over the same period. Similarly, Bank of America’s ROE was 6.29, 6.82, and 6.83 compared to JP Morgan’s 10.34, 10.27 and 9.86 for the three years under review and as shown in the following table Wells Fargo outperformed Bank of America and JP Morgan with regard to ROE and other selected metrics. Metric 2015 2016 2017 Return on Assets (ROA) % 1.24 1.10 1.06 Return on Equity (ROE) % 12.78 11.78 11.53 Financial Leverage 10.47 11.03 10.75 Net Margin % 25.61 23.31 23.59 Fixed Asset Turnover 9.61 10.26 10.14 Total Asset Turnover 0.05 0.05 0.04 Free Cash Flow/Net Income 0.65 0.01 0.84 Selected profitability and managerial efficiency ratios (Source: Morningstar, 2018) Current Financial Health Capitalization Wells Fargo’s assets just like any other company are financed with debt and equity, and analysis of the company’s capital structure indicates that it has a very good mix of debt and equity in deed. The company’s market value of equity based on its closing price on May 24, 2018 was $266.4 billion. The market value of debt is typically difficult to calculate, but based on the numbers from Wells Fargo’s financial report for the financial year ended 2017 we can use the book value of debt to do the calculation. Calculation of market value of debt is simplified by adding the latest two-year average current portion of long-term debt and long-term debt & capital lease obligation together. Wells Fargo's latest two-year average current portion of long-term debt was $16.7 billion and its latest two-year average long-term debt & capital lease obligation was $240 billion. Based on these figures, the company’s total book value of debt is $256.7 billion, therefore the portion of equity in the company’s total capital is 51% compared to 49% debt as shown in the calculations below: a) Weight of equity = E / (E + D) = 266.4 / (265.4 + 256.7) = 51% b) Weight of debt = D / (E + D) = 256663 / (266.4 + 256.7) = 49% Resources to Fuel Future Growth According to Wells Fargo (2018), the company had approximately $2.0 trillion in assets at the end of the 2017 financial year, loans of $957 billion, deposits of $1.3 trillion and stockholders’ equity of $207 billion. Additionally, the company had 91.1 million total square footage of property occupied as shown in appendix 5. Based on assets, Wells Fargo is the third largest bank holding company in the United States with Wells Fargo Bank, N.A. being the company’s principal subsidiary with assets of $1.7 trillion, or 90% of the company’s assets. At December 31, 2017, Wells Fargo had 262,700 active, full-time equivalent team members, thus the company’s revenue per employee based on the figures in appendix 1 was $401,427 while income per employee was $84,442. Appendix 2 shows that Wells Fargo added $1.6 billion and $2.6 billion to its cash reserves in 2016 and 2017 respectively. The company’s total cash at the end of the financial year was $23.4 billion, thus Wells Fargo has the right amount of cash and other resources to fuel future growth. Financial Value of the Company Enterprise value (EV) is one of the key valuation metrics that gives an indication of a company’s future prospects. EV is calculated as the market capitalization plus debt and minority interest and preferred shares, minus total cash, cash equivalents, and marketable securities. Based on Wells Fargo’s financial statements for the financial year ended 2017, and the company’s closing stock price of $60.67 on December 29, 2017, Wells Fargo’s EV value at the end of 2017 was about $540 billion. The following is a summary of the EV calculation based on values obtained from the company’s financial statements: EV = Market Capitalization + Preferred Stock + Long-Term Debt & Capital Lease Obligation + Current Portion of Long-Term Debt + Minority Interest - Cash, Cash Equivalents, Marketable Securities EV = 296774.58 million + 25358 million + 225020 million + 14572 million + 1143 million - 23367 million EV = 539,501 million According to tradingeconomics.com (2018), Wells Fargo’s EV at the end of Q1 2018 was 633B. Given the company’s EV of approximately $540 billion at the end of 2017, this indicates that the company’s EV increased by about 17% within the first three months of 2018. Another indicator that provides insight into Wells Fargo’s financial value and investor perceptions about the company\s future is market capitalization. Market capitalization is calculated by multiplying a company’s stock price with the number of total shares outstanding. According to Bloomberg (2018), Wells Fargo’s closing price on May 24, 2018 was $54.67 and the company’s total shares outstanding as shown in its 2017 balance sheet was 4,872,874,000. Consequently, Wells Fargo’s market capitalization on May 24, 2018 was: Market Capitalization = $54.67 x 4,872,874,000 = $266.4 billion As noted in the EV calculations above, Wells Fargo’s closing price on December 29, 2017 was $60.67 which means that the company’s market capitalization at the end of 2017 was $295.6 billion (Market Capitalization = $60.67 x 4,872,874,000), an amount that is approximately 11% higher than the current market capitalization. However, the company’s 52-week high stock value of $66.31 was in February 2018 while the 52-week low stock value of $49.27 was in September 2017. This indicates that over the past 1 year, Wells Fargo’s market capitalization has ranged between $240 billion and $323 billion. The current market capitalization is 11% higher than the 52-week low which is an indication that investors have confidence in the company’s future and expect it to perform well. The following table presents a summary of other key valuation metrics for Wells Fargo which show that the company is in a strong financial position: Metric 2015 2016 2017 Price/Sales 3.40 3.24 3.54 Price/Earnings 13.13 13.67 15.68 Price/Book 1.62 1.55 1.65 Price/Forward Earnings 12.27 13.19 13.83 PEG Ratio 2.56 2.35 1.57 Earnings Yield % 7.62 7.31 6.38 Selected valuation metrics for Wells Fargo (Source: Marketwatch, 2018) Success Factors And Risks Effects of financial and strategic priorities on accounting procedures and business decisions and how to better capitalize on non-financial factors According to Wells Fargo (2018), the five strategic priorities that provide direction for WFC’s business decisions are: focusing on the customer, building the best team, enhancing risk management, managing performance and finally strengthening financial performance. These strategic priorities are important because WFC’s financial statements are based in part on assumptions and estimates which, if wrong, could cause unexpected losses in the future. WFC’s management is responsible for formulating and overseeing the implementation of accounting procedures, thus the company’s accounting procedures and business decisions are likely to be affected by financial and strategic priorities because the company’s management is responsible for both. Additionally, WFC’s financial statements depend on the company management’s internal controls over financial reporting, therefore they are likely to be affected by management’s perspectives regarding financial and strategic priorities (Wells Fargo, 2018). Pursuant to U.S. GAAP, the management of WFC is required to use certain assumptions and estimates when preparing annual financial statements. One of the areas where management makes assumptions is determination of reserves such as credit loss, mortgage repurchases and litigation among others. Additionally, management estimates the fair value of certain assets and liabilities and as pointed out earlier, one of WFC’s strategic priorities is to strengthen financial performance. This strategic priority raises the likelihood of management’s overestimation of certain assets or under-allocation of reserves. It is also important to note that WFC accounting policies require management to make difficult, subjective and complex judgments about matters that are inherently uncertain (Wells Fargo, 2018). Consequently, there is high likelihood of WFC experiencing material losses if management’s assumptions or estimates underlying the company’s financial statements are incorrect. WFC’s executive management’s strategic plan for the period 2016 to 2021 which is the period under which the projections discussed in this paper lie imply a growth-focused management, so the company is expected to continue on its recent growth trajectory. The company’s vision statement is to satisfy customers’ financial needs and help them to succeed financially (Morningstar, 2018), thus the WFC management’s focus is to reinforce the company’s risk infrastructure, diversify its portfolio. Additionally, the company aims to become more productive and integrated, capitalize on its global capabilities, achieve rising recognition and increase focus on relationship banking. WFC’s key areas of improvement over the next few years include increasing digital sales, upgrading compliance infrastructure, building a differentiated brand positioning, improving the quality of its end-to-end processes and finally cultural shift to improve satisfaction (Wells Fargo, 2018). The most significant internal risks to WFC’s financial performance WFC faces multiple significant internal risks that may affect the company’s financial performance. One of the significant internal risks to the company’s financial performance is acquisitions which form a significant part of WFC’s expansion strategy. WFC regularly explores opportunities to expand its products, services and assets through acquisitions. Acquiring a business in the financial services industry often requires federal regulatory approval and since WFC is effectively a multinational the level of regulatory scrutiny when it comes to acquiring businesses in other countries is even higher. Additionally, regulatory approval has become more complex as a result of the Dodd-Frank Act, thus at times the company may be forced to dispose some business units or assets or to issue additional equity in order to meet the conditions for regulatory approval (Wells Fargo, 2018). The other significant internal risk WFC faces relates to the company’s ability to attract and retain qualified team members. This is critical to the company’s success and given its size and the stiff competition it faces not only from the top financial industry companies but also from technology companies targeting to disrupt some financial industry services. Failure to attract and retain qualified team members could adversely affect WFC’s business performance, competitive position and future prospects including financial performance. WFC’s success heavily relies on the talents and efforts of its people including senior managers and the competition for qualified personnel is very high. To attract and retain qualified personnel necessitates competitive compensation which in turn requires the company to increase its expenses subject to regulatory limitation on compensation thereby affecting overall financial performance (Marketwatch, 2018). WFC maintains systems and procedures designed to ensure that the company is in compliance with applicable laws and regulations. However, there is still a likelihood of incurring fines, penalties and other negative consequences as a result of inadvertent or unintentional regulatory violations (Wells Fargo, 2018). Being in a fast growing industry characterized by emergence of new technologies and consolidation among top players, WFC is subject to heightened compliance and regulatory oversight and expectations. Furthermore, the financial industry regulatory framework is rapidly evolving, thus the company is at the risk of events that may result to overlapping investigations by federal agencies as well as other agencies in the countries and territories WFC operates in. Compliance difficulties may also arise from differences in laws and regulations with regard to internally developed products that WFC may roll out (Wells Fargo, 2018). Another significant internal risk to WFC’s financial performance relates to sales practices. Some of the company’s sales practices have resulted in settlements with the Consumer Financial Protection Bureau, the Office of the Comptroller of the Currency and the Office of the Los Angeles City Attorney. Additionally, the company has faced monetary penalties and other sanctions as a result of its sales practices but most importantly, regulatory authorities may impose conditions such as admissions of wrongdoing which may in turn mean that the company cannot engage in certain business activities or offer certain products and services. This would clearly have a negative impact on WFC’s financial performance due to loss of customers, inability to access capital markets and limitations on capital distributions (Wells Fargo, 2018). WFC is a large financial institution with over 8,300 locations and a network of 13,000 ATMs. Additionally, the company serves millions of customers through the internet, mobile banking and other distribution channels across the U.S. and internationally and depends on its ability to process, record and monitor a large number of customer transactions on a continuous basis. Expansion of the company’s business locally and abroad makes the company vulnerable to operational systems failure and significant investments in safeguarding controls and infrastructure, and monitoring potential failures, disruptions and breakdowns (Wells Fargo, 2018). WFC’s business, financial, accounting, data processing systems or other operating systems and facilities may stop operating properly, or become disabled or damaged as a result of a number of factors thereby exposing the company to financial loss. The other significant internal risk that WFC faces is that the company relies on dividends from its subsidiaries for liquidity and the company’s ability to meet its financial obligations is a key factor in its ability to operate profitably. Federal and state law or other contractual arrangements can limit the dividends thereby affecting the company’s financial performance. WFC’s parent holding company is a separate and distinct legal entity from its subsidiaries and it receives it receives funding and liquidity from dividends and other distributions from subsidiaries. These dividends and distributions are used to pay dividends on the company’s common and preferred stock as well as interest and principal on debt (Wells Fargo, 2018). WFC’s inability to meet the aforementioned obligations due to limitations on dividends from subsidiaries by federal and state laws can negatively affect the company’s valuation and result in poor financial performance. Lastly, WFC generates revenue from the interest and fees it charges on the loans and other products and services the company sells. However a substantial amount of the company’s revenue and earnings come from the net interest income and fee income earned from consumer and commercial lending and banking businesses, including mortgage banking business where WFC is currently the largest mortgage originator in the U.S. A weakening in business or economic conditions, including higher unemployment levels or declines in home prices, can adversely affect borrowers’ ability to repay their loans, which can negatively impact WFC’s credit performance. Additionally, weak or deteriorating economic conditions make it more challenging for WFC to increase its consumer and commercial loan portfolios by making loans to creditworthy borrowers at attractive yields, thereby negatively affecting the company’s financial performance (Wells Fargo, 2018). Projections Projected consolidated financial performance 2018 – 2020 Appendices 1 and 2 shows WFC’s projected consolidated financial performance for the next three years based on analysis of the company’s past performance. Past performance is often the best predictor of future performance, thus the assumptions applied to the projections were drawn from analyzing WFC income statements over the last 5 years and the company’s balance sheets over the last three years. The underlying assumption in the projected financials is that there will not be significant changes in managerial approach, thus the company will continue to grow its asset base by about 5% annually. Additionally, projected income statements for 2018 to 2020 are based on assumption that the company will continue to grow its total revenues by about 1.45% annually and that there will not be significant changes in its expenses structure. Analysis of WFC’s consolidated income statements for the past five years revealed that the company achieved growth in terms of revenues, but its net income has slightly declined. Appendix 6 contains the company’s five-year average consolidated income statements trend and common-size analysis. Interest income was 58.78%, 61.41% and 67.62% of total revenues in 2015, 2016 and 2017 respectively, so the company achieved consistent growth in terms of interest income. Trend analysis of interest income show that it improved from 8.90% in 2016 to 9.78% in 2017. However, non-interest income was 45.96%, 45.35%, and 43.12% of total revenues in 2015, 2016 and 2017 respectively whereas non-interest expense was 59.62%, 59.94%, and 67.13% of total revenues in 2015, 2016 and 2017 respectively. This shows that the bank incurred more costs to earn non-interest revenue and as a result its net income decreased by 4.18% in 2016 and 1.12% in 2017. Another major assumption related to WFC’s projected financial performance is that there will be no major acquisition that will result in changes among the top three financial services companies in the foreseeable future. Analysis of the company’s cash flow statements showed that there was a major acquisition in 2016, but despite the acquisition there was a 5% drop in profits compared to the previous financial year. As shown in Appendix 6, WFC’s net income will increase from $22,011 million in 2018 to $22,330 million in 2019 and $22,654 in 2020. Additionally, WFC’s key profitability and managerial efficiency ratios show that the company’s performance has been relatively stable in the last three years and that the company is thriving in its industry, thus this performance is projected to continue. Modified projections and the effect of assumptions, forecasting methodology and information gaps on the financial projections Appendix 7 shows that WFC’s asset base will grow at a rate of 5% based on the past performance. However, these projections are inherently uncertain because it is not possible to accurately predict the operating conditions WFC will face in the next year. Consequently, appendices 3 and 4 present modified financial projections for 2018 assuming that the company will make unforeseen decisions that will either result in its net income shrinking by 5% or growing by 5% as opposed to the previously projected growth rate of 1.45% annually. Under a best case scenario, WFC will earn a net income of $22,781 million whereas under the worst case scenario the company will earn $20,612 million, therefore the company is expected to remain profitable no matter what happens in 2018. Similarly assets will increase to $2,146,933 million in the best case scenario or reduce to $1,854,169 million in the worst case scenario implying that WFC will remain the third biggest financial services company in 2018. As highlighted in the success factors and risk section above, WFC accounting policies require management to make difficult, subjective and complex judgments about matters that are inherently uncertain (Wells Fargo, 2018). Similarly, while past performance is often a good indicator of future performance, there is no way of telling exactly what will happen in the future or the actions that WFC’s management will take. Should the company adopt a more aggressive expansion strategy in a bid to overtake the two leading financial services companies, its balance sheet and earnings outlook will differ from the projections shown in appendices 1 to 4. The assumption of 5% growth in assets and 1.45% growth in net income presumes that there will be no major acquisitions or divestures for WFC in the foreseeable future, but for a company that is facing completion from both traditional financial services companies and other technology companies there is no certainty that there will not be major M&A activity. The financial projections therefore are only estimates based on limited information and past trends. Business Opportunities Likely investment Wells Fargo would consider Wells Fargo regularly explores opportunities to expand the company’s products, services and assets by acquiring companies or businesses in the financial services industry (Wells Fargo, 2018). However, given the strict regulatory framework in the industry the company operates in, any such acquisitions generally require federal regulatory approvals which may be difficult to obtain. According to Wells Fargo (2018) strict regulation is one of the major risks faced by the company. There is also the risk of difficulty in integrating acquired companies or businesses which may limit the realization of the expected benefits such as increased revenues or cost savings. Despite the risks highlighted above however, a review of Wells Fargo’s financial statements indicate that the company has been active in mergers and acquisitions (M&As), as well as in acquiring assets such as business units from other financial services companies over the last 5 years. While M&As remain a favored approach to expanding the size of financial services companies, the top industry players like JPMorgan chase, Bank of America and Wells Fargo face strict scrutiny that may hinder high value M&As. Consequently, Wells Fargo may have to explore acquiring business units or other asset classes in a bid to consolidate its market position (Wells Fargo, 2018). One particular asset class that has attracted Wells Fargo’s interest in the last few years is mortgage servicing rights (MSRs). Consequently, acquiring MSRs from a credit union such as Navy Federal Credit Union (“Navy Federal”) is a likely investment Wells Fargo would consider. An MSR is a contractual agreement between an original lender and another party that specializes in the various functions of servicing mortgages that party acquires the rights to service an existing mortgage sold by the original lender. When Wells Fargo acquired $51 billion in MSRs from Seneca Mortgage Investments (Seneca) in September 2017, the company’s head of consumer lending, Franklin Codel noted that MSRS were an attractive core business for Wells Fargo. Codel further noted that the acquisition of Seneca’s MSRs provided Wells Fargo an opportunity to strategically enhance its servicing portfolio. In deed third party MSRs were always a core asset class for Wells Fargo until the 2008 financial crisis when the Office of the Comptroller of the Currency issued restrictions on buying of MSRs by big banks following an agreement that has since been terminated. Wells Fargo remains the largest mortgage servicer in the US, and the termination of the agreement with the Office of the Comptroller of the Currency in May 2016 marked the beginning of renewed MSRs acquisitions by the bank as it seeks to consolidate its position. Navy Federal’s MSRs present a good investment opportunity for Wells Fargo, and based on the company’s renewed focus on acquiring third party MSRs to consolidate its position as the largest mortgage servicer, Navy Federal’s MSRs is definitely an investment Wells Fargo would likely consider. Navy Federal is the largest credit union in the country with nearly $90 billion in total assets, a net worth of $ 11 billion and about 4.8 million members. The credit union is well capitalized and out of its total assets at the end of the 2017 financial year, about 75% comprised of loans. Additionally, out of the $67 billion in loans the company held at the end of 2017 about 50% ($33.5 billion) were real estate loans, thus even though it is not as large as Seneca, Navy Federal’s MSRs still present a significant asset that can contribute to Wells Fargo’s push to consolidate its position as the market leader when it comes to mortgage servicing. The following table show the value of total mortgage servicing portfolios for the top 5 financial service companies in 2017: Financial Company Own Mortgages Third Party Mortgages Total Mortgages Serviced Wells Fargo $343 $1,189 $1,532 JPMorgan Chase 260 568 828 Bank of America 259 284 543 U.S Bancorp 59 232 291 City Bank 68 64 132 Total $989 $2,337 $3,326 Table 1: Comparison of mortgage servicing portfolios among the top 5 banks [Figures in billions of dollars] Wells Fargo enjoys a competitive advantage over its top two competitors, JPMorgan Chase and Bank of America when it comes to mortgage servicing and acquiring MSRs from third party mortgage issuers. The company’s mortgage servicing unit had a portfolio of about $1.5 trillion at the end of 2017 which represents almost 80% of the company’s total assets at the end of 2017 and is much higher than the portfolios of the two top competitors. This gives the company clout as the expert in this asset class compared to other large banks, so third party sellers are likely to prefer the market leader. Additionally, Wells Fargo uses Loansphere MSP to service its mortgages and this is the same system that Navy Federal and a majority of credit unions use. Consequently, it would be easier and faster for Wells Fargo and Navy Federal to complete servicing transfers because the data and file formats are similar (Broughton, 2017), thus Navy Federal’s MSRs is an investment that Wells Fargo would likely consider. Evaluation of the approximate costs and benefits of the investment This section presents an estimate of the approximate costs and associated benefits that Wells Fargo is likely to incur should it opt to acquire Navy Federal’s MSRs. Analysis of Wells Fargo’s and Navy Federal’s prevailing market rates for mortgages indicate that Wells Fargo’s rates were generally lower than those of Navy Federal by as much as 1% in some mortgage categories. Consequently, purchasing the MSRs for Navy Federal presents an opportunity for Wells Fargo to acquire an asset that can help the company shore up its balance sheet and increase revenue, while giving Navy Federal access to the expertise of the biggest financial services company when it comes to mortgage servicing. Table 2 below shows Wells Fargo prevailing market rates for mortgages compared with equivalent products from Navy Federal: WELLS FARGO NAVY FEDERAL Product Interest Rate APR Interest Rate APR 30-Year Fixed Rate/HomeBuyers 4.750% 4.810% 5.375% 5.674% 30-Year Fixed-Rate VA/Military Choice 4.500% 4.812% 5.250% 5.547% 20-Year Fixed Rate/30 Yr FHA 4.625% 4.677% 3.875% 5.590% 15-Year Fixed Rate/HomeBuyers Choice 4.250% 4.390% 4.875% 5.378% 7/1 ARM/1 Yr FHA ARM 4.375% 4.776% 3.875% 5.624% 5/1 ARM/3 Yr FHA ARM 4.375% 4.827% 4.625% 5.841% 30-Year Fixed-Rate Jumbo/HomeBuyers 4.625% 4.646% 5.500% 5.802% 15-Year Fixed-Rate Jumbo/HomeBuyers 4.500% 4.516% 5.000% 5.505% 7/1 ARM Jumbo/Military Choice 4.125% 4.598% 5.375% 5.674% 10/1 ARM Jumbo/HomeBuyers Choice 4.375% 4.617% 5.500% 5.802% Table 2: Wells Fargo and Navy Federal prevailing mortgage purchase rates [Wells Fargo, 2018; Navy Federal, 2017] As shown in table 2 above, there are significant differences between Wells Fargo and Navy Federal mortgage rates, thus both companies stand to benefit from the MSRs investment. Based on the 2017 financial report for Navy Federal, the union had $1.26 billion in total interest income and $225 million in total interest expenses. This means that Wells Fargo can acquire the union’s MSRs at a price that would enable the company to make a profit from servicing mortgages originated by Navy Federal while Navy Federal would benefit from reduced interest expenses which would free up finances for other investments. Calculating the net present value (NPV) of Navy Federal’s mortgage loans were Wells Fargo to acquire the union’s MSRs can help to illustrate how this can be achieved. The NPV of Navy Federal’s MSRs can only be determined if Wells Fargo’s weighted average cost of capital (WACC) is known as this would act as the discount rate to assess whether the MSRs are a worthwhile investment for Wells Fargo. WACC is the average rate that a company is expected to pay all of its security holders to finance its assets, so it is a critical metric in evaluating investments. The WACC is commonly referred to as the cost of capital, and it is determined by the external market and not by a company’s management. Generally speaking, a company's assets are financed by debt and equity therefore the first step towards determining WACC is to calculate the weight of equity and the weight of debt. The following is Wells Fargo’s WACC based on the company’s actual results for the previous two financial years: Determining the weights a) Weight of equity = E / (E + D) = 266400.010 / (266400.010 + 256663) = 51% b) Weight of debt = D / (E + D) = 256663 / (266400.010} + 256663) = 49% Cost of equity Cost of equity = Risk free rate + beta x market premium Cost of Equity = 2.98000000% + 1.25 x 6% = 10.48% Cost of debt Cost of debt = Interest expense / book value of debt Cost of Debt = 9352 / 256663 = 3.6437% WACC WACC = E / (E + D) x Cost of Equity + D / (E + D) x Cost of Debt x (1 - Tax Rate) WACC = 0.5093 x 10.48% + 0.4907 x 3.6437% x (1 - 24.665%) WACC = 6.68% Wells Fargo’s WACC is approximately 6.68%, and using this rate as the cost of capital indicates that Navy Federal’s MSRs has a present value of approximately $4 million to Wells Fargo assuming an average repayment period of 20 years and a service fee of 0.25%. Appendix 12 shows the present value calculations for the additional interest revenue that the MSRs would add to Wells Fargo’s income statement. Should Wells Fargo acquire this asset, it would add a net interest income of about $500 million annually to its income statement as shown in Appendix 10, but the required $5.2 billion cash outlay required to acquire the MSRs from Navy Federal would have an impact on Wells Fargo’s projected balance sheet as shown in Appendix 11. Conclusively, the investment would be beneficial to Wells Fargo. Effect of the potential investment on budgeting and related business decisions A major assumption related to Wells Fargo’s projected financial performance was that there would be no major acquisitions that would result in changes among the top three financial services companies in the foreseeable future. This is presumed to remain the case because a $5.2 billion acquisition of a credit union’s MSRs would not cause Wells Fargo to overtake Bank of America, but it would improve the company’s position as the biggest mortgage servicer. This would enable Wells Fargo to consolidate its position in a segment it holds a competitive advantage. Analysis of the company’s cash flow statements showed that there was a major acquisition in 2016, but despite the acquisition there was a 5% drop in profits compared to the previous financial year. Acquisition of Navy Federal’s MSRs would require Wells Fargo to spend $5,200 million of the company’s cash reserves thereby reducing its cash reserves from $23,367 million to $17,519 million. Without the investment in Navy Federal’s MSRs, Wells Fargo’s net income would have been $23,437million in 2018 but with the investment the company’s net income would increase to $23,955 million. Additionally, Wells Fargo’s key profitability and managerial efficiency ratios indicate that the company’s performance has been relatively stable in the last three years and that the company is thriving in its industry, thus this performance is projected to continue. The managerial efficiency metrics would be negatively affected by the investment because the initial cash outlay would be taken out of the cash reserves, whereas the MSRs acquisition would be reflected under long-term assets. The initial cash outlay would reduce cash reserves by about 22% and because this asset comprises a significant portion of the company’s total current assets, the outlook of its liquidity would be reduced thus it might require additional current assets to get favorable short-term loans. Lastly, Wells Fargo generates revenue from the interest and fees it charges on the loans and other products and services the company sells. However, a substantial amount of the company’s revenue and earnings come from the net interest income and fee income earned from consumer and commercial lending and banking businesses, including mortgage banking business where WFC is currently the largest mortgage originator in the U.S. Investing in Navy Federal’s MSRs would further increase Wells Fargo’s exposure. A weakening in business or economic conditions, including higher unemployment levels or declines in home prices, can adversely affect borrowers’ ability to repay their loans, which would in turn increase the company’s credit performance. Additionally, weak or deteriorating economic conditions coupled with such an investment would make it more challenging for WFC to increase its consumer and commercial loan portfolios thereby negatively affecting the company’s budgeting and related business decision. Recommendations Analysis of Wells Fargo’s consolidated balance sheets and cash flow statements revealed that the company’s total cash at the end of the financial year ended 2017 was $23.4 billion, therefore the company has the right amount of cash and other resources to fuel future growth. High level M&As have shaped the financial services industry over the last decade, but as shown in the risk assessment section of this report the industry is highly regulated so major high-level M&A activity that may change the competitive outlook of the top financial industry player in the short-term is likely to fail regulatory approval. Consequently, it is recommended that Wells Fargo capitalizes on its market dominance on mortgage servicing by acquiring Navy Federal’s MSRs at a cost of $5.2 billion. This opportunity will enable the company to further enhance its market dominance of the mortgage servicing aspect of financial services, and consolidate its market position. Based on the Wells Fargo’s capital structure as shown in its 2017 balance sheet, the company’ WACC is approximately 6.68%, and using this rate as the cost of capital indicates that Navy Federal’s MSRs have a present value of approximately $4 million to Wells Fargo assuming an average repayment period of 20 years and a service fee of 0.25%. Appendix 3 shows the present value calculations for the additional interest revenue that the MSRs would add to Wells Fargo’s income statement. Should Wells Fargo acquire this asset, it would add a net interest income of about $500 million annually to its income statement as shown in appendix 1, but the required $5.2 billion cash outlay required to acquire the MSRs from Navy Federal would have an impact on Wells Fargo’s projected balance sheet as shown in appendix 2. Conclusively, the investment would be beneficial to Wells Fargo and my recommendation is to take the opportunity and acquire Navy Capitals MSRs. References Bloomberg (2018) Wells Fargo & Co. Retrieved from https://www.bloomberg.com/quote/WFC:US, Accessed on May 22, 2018. Broughton, K. (2017, Sep 07). Wells Fargo acquires $51 billion in mortgage servicing rights. Retrieved from https://www.nationalmortgagenews.com/news/wells-fargo-acquires-51-billion-in-mortgage-servicing-rights. Accessed on June 12, 2018. Marketwatch (2018). Wells Fargo & Co. Retrieved from https://www.marketwatch.com/investing/stock/wfc/profile. Accessed on May 23, 2018. Marketwatch (2018). Wells Fargo & Co. Retrieved from https://www.marketwatch.com/investing/stock/wfc/profile. Accessed on May 23, 2018. Morningstar (2018). Wells Fargo & Co. Retrieved from http://www.morningstar.com/stocks/xnys/wfc/quote.html. Accessed on May 22, 2018. Morningstar (2018). Wells Fargo % Co. Retrieved from http://www.morningstar.com/stocks/xnys/wfc/quote.html. Accessed on May 22, 2018. Navy Federal Credit Union (2018). Mortgage rates. Retrieved from https://www.navyfederal.org/assets/rates/printMortRates.php. Accessed on June 10, 2018. Trading Economics, (2018). Wells Fargo enterprise value. Retrieved from https://tradingeconomics.com/wfc:us:enterprise-value. Accessed on May 23, 2018. Wells Fargo & Company (2018). Form 10-K. Retrieved from https://www.sec.gov/Archives/edgar/data/72971/000007297118000272/wfc-12312017x10k.htm. Accessed on May 22, 2018. Wells Fargo & Company (2018). Form 10-K. Retrieved from https://www.sec.gov/Archives/edgar/data/72971/000007297118000272/wfc-12312017x10k.htm. Accessed on May 22, 2018. Wells Fargo & Company (2018a). Form 10-K. Retrieved from https://www.sec.gov/Archives/edgar/data/72971/000007297118000272/wfc-12312017x10k.htm. Accessed on June 10, 2018. Wells Fargo & Company (2018b). Today’s mortgage rates and refinance rates. Retrieved from https://www.wellsfargo.com/mortgage/rates/. Accessed on June 10, 2018.  Appendix 1: Income statement with vertical and horizontal analysis COMMON-SIZE ANALYSIS TREND ANALYSIS USD in millions 2015 2016 2017 2015 2016 2017 2016 2017 Loans and Leases 37,379 40,298 42,186 44.59% 46.11% 48.42% 7.81% 4.69% Other assets 11,898 13,365 16,723 14.19% 15.29% 19.20% 12.33% 25.13% Total interest income 49,277 53,663 58,909 58.78% 61.41% 67.62% 8.90% 9.78% Interest expense Deposits 963 1,395 3,013 1.15% 1.60% 3.46% 44.86% 115.99% Short-term borrowing 64 330 758 0.08% 0.38% 0.87% 415.63% 129.70% Other expense 2,949 4,184 5,581 3.52% 4.79% 6.41% 41.88% 33.39% Total interest expense 3,976 5,909 9,352 4.74% 6.76% 10.73% 48.62% 58.27% Net interest income 45,301 47,754 49,557 54.04% 54.65% 56.88% 5.41% 3.78% Noninterest revenue Commissions and fees 34,181 33,374 31,473 40.78% 38.19% 36.13% -2.36% -5.70% Lending and deposit-related fees 14,379 13,968 11,983 17.15% 15.98% 13.75% -2.86% -14.21% Securities gains (losses) 1,416 2,231 2,082 1.69% 2.55% 2.39% 57.56% -6.68% Credit card income 3,720 3,936 3,960 4.44% 4.50% 4.55% 5.81% 0.61% Insurance premium 1,694 1,268 1,049 2.02% 1.45% 1.20% -25.15% -17.27% Other income (16,864) (15,143) (12,983) -20.12% -17.33% -14.90% -10.21% -14.26% Total noninterest revenue 38,526 39,634 37,564 45.96% 45.35% 43.12% 2.88% -5.22% Total net revenue 83,827 87,388 87,121 100.00% 100.00% 100.00% 4.25% -0.31% Provisions for credit losses 2,442 3,770 2,528 2.91% 4.31% 2.90% 54.38% -32.94% Noninterest expenses Compensation and benefits 30,681 31,893 33,371 36.60% 36.50% 38.30% 3.95% 4.63% Occupancy expense 2,886 2,855 2,849 3.44% 3.27% 3.27% -1.07% -0.21% Tech, communication and equipment 2,063 2,154 2,237 2.46% 2.46% 2.57% 4.41% 3.85% Other expenses 14,344 15,475 20,027 17.11% 17.71% 22.99% 7.88% 29.42% Total noninterest expenses 49,974 52,377 58,484 59.62% 59.94% 67.13% 4.81% 11.66% Income from cont. ops before taxes 31,411 31,241 26,109 37.47% 35.75% 29.97% -0.54% -16.43% Provision (benefit) for taxes 10,365 10,075 4,917 12.36% 11.53% 5.64% -2.80% -51.20% Other income (expense) 1,848 772 991 2.20% 0.88% 1.14% -58.23% 28.37% Net income 22,894 21,938 22,183 27.31% 25.10% 25.46% -4.18% 1.12% Preferred dividend 1,424 1,565 1,629 1.70% 1.79% 1.87% 9.90% 4.09% Net inc’m avb’l to common shareholders 21,470 20,373 20,554 25.61% 23.31% 23.59% -5.11% 0.89% Appendix 2: Cash flow statements with horizontal analysis TREND ANALYSIS USD in millions 2015 2016 2017 2016 2017 Cash Flows From Operating Activities Provision for credit losses 2,442 3,770 2,528 54.38% -32.94% Depreciation & amortization 3,288 4,970 5,406 51.16% 8.77% Stock based compensation 1,958 1,945 2,046 -0.66% 5.19% Receivable (623) - - -100.00% - Payables 160 - - -100.00% - Accrued liabilities (6,964) (705) 4,837 -89.88% -786.10% Deferred charges (2,265) 1,793 666 -179.16% -62.86% Other assets and liabilities 45,480 50,407 27,133 10.83% -46.17% Other operating activities (28,704) (62,011) (23,894) 116.04% -61.47% Net cash provided by operating activities 14,772 169 18,722 -98.86% 10978.11% Cash Flows From Investing Activities Change in federal funds sold (11,866) 3,991 (13,490) -133.63% -438.01% Sales/maturity of investments 68,129 82,621 103,079 21.27% 24.76% Purchases of investments (107,554) (148,889) (106,694) 38.43% -28.34% Changes in loans, net (61,656) (36,061) 7,688 -41.51% -121.32% Acquisitions and dispositions (3) (30,584) (320) 1019366.67% -98.95% Other investing activities 5,715 6,803 4,573 19.04% -32.78% Net cash used for investing activities (107,235) (122,119) (5,164) 13.88% -95.77% Cash Flows From Financing Activities Change in deposits 54,867 82,767 29,912 50.85% -63.86% Change in short-term borrowing 34,010 (1,198) 14,020 -103.52% -1270.28% Long-term debt issued 43,030 90,111 43,575 109.41% -51.64% Long-term debt repayment (27,333) (34,462) (80,802) 26.08% 134.47% Excess tax benefit from stock based compensation 453 283 -37.53% -100.00% Common stock issued 1,726 1,415 1,211 -18.02% -14.42% Preferred stock issued 2,972 2,101 677 -29.31% -67.78% Repurchases of treasury stock (8,697) (8,116) (10,301) -6.68% 26.92% Cash dividends paid (8,826) (9,038) (9,109) 2.40% 0.79% Other financing activities (199) (295) (103) 48.24% -65.08% Net cash provided by (used for) financing activities 92,003 123,568 (10,920) 34.31% -108.84% Net change in cash (460) 1,618 2,638 -451.74% 63.04% Cash at beginning of period 19,571 19,111 20,729 -2.35% 8.47% Cash at end of period 19,111 20,729 23,367 8.47% 12.73%  Appendix 3: Debt securities, loans and total assets trends 2015-2017 Appendix 4: Deposits, debt, retained earnings, liabilities and equity trends 2015-2017  Appendix 5: Square footage of property occupied in millions December 31, 2017    Approximate square footage (in millions) United States     San Francisco, California      420 Montgomery Street (corporate headquarters)   0.3 All other San Francisco locations   4.2 Total San Francisco, California   4.5       Top 10 other U.S. locations:     Charlotte-Concord-Gastonia, NC-SC   7.4 Minneapolis-St. Paul-Bloomington, MN-WI    6.0 Los Angeles-Long Beach-Anaheim, CA    4.1 Phoenix-Mesa-Scottsdale, AZ    3.6 New York-Newark-Jersey City, NY-NJ-PA    3.5 Des Moines-West Des Moines, IA    3.4 St. Louis, MO-IL    2.5 Philadelphia-Camden-Wilmington, PA-NJ-DE-MD    2.2 Dallas-Fort Worth-Arlington, TX    1.9 Atlanta-Sandy Springs-Roswell, GA    1.7 All other U.S. locations    47.4 Total United States    88.2        Top 5 International locations:      India    1.5 Philippines    0.5 Canada   0.2 United Kingdom   0.2 China   0.2 All other international locations    0.3 Total International    2.9       Total square footage property occupied   91.1  Appendix 6: Projected income statements 2018 – 2020 with actual 2017 income statement as the base year USD in millions 2017 5-Year Average Common-Size 4-Year Average Trend 2018 2019 2020 Revenue                   Interest income                   Loans and Leases 42,186   46%   3%   40,383 40,968 41,562 Other assets 16,723   15%   13%   13,183 13,374 13,568 Total interest income 58,909   61%   6%   53,566 54,343 55,130 Interest expense                   Deposits 3,013   2%   33%   1,620 1,644 1,667 Short-term borrowing 758   0%   138%   260 263 267 Other expense 5,581   4%   19%   3,841 3,896 3,953 Total interest expense 9,352   6%   25%   5,720 5,803 5,887 Net interest income 49,557   54%   4%   47,846 48,540 49,243 Noninterest revenue                   Commissions and fees 31,473   40%   -2%   35,032 35,540 36,055 Lending and deposit-related fees 11,983   17%   -8%   15,019 15,237 15,458 Securities gains (losses) 2,082   2%   47%   1,658 1,683 1,707 Credit card income 3,960   4%   6%   3,809 3,865 3,921 Insurance premium 1,049   2%   -12%   1,573 1,596 1,619 Other income (12,983)   -19%   -7%   (16,554) (16,794) (17,038) Total noninterest revenue 37,564   46%   -1%   40,538 41,125 41,721 Total net revenue 87,121   100%   1%   88,384 89,665 90,964 Provisions for credit losses 2,528   3%   14%   2,587 2,625 2,663 Noninterest expenses                   Compensation and benefits 33,371   37%   3%   32,621 33,094 33,574 Occupancy expense 2,849   3%   0%   3,017 3,060 3,105 Tech, communication and equipment 2,237   2%   3%   2,176 2,208 2,240 Other expenses 20,027   18%   10%   16,250 16,485 16,724 Total noninterest expenses 58,484   61%   5%   54,064 54,847 55,642 Income (loss) from cont. ops before taxes 26,109   36%   -4%   31,733 32,193 32,659 Provision (benefit) for taxes 4,917   11%   -14%   9,679 9,819 9,961 Other income (expense) 991   2%   8%   1,383 1,403 1,424 Net income 22,183   27%   0%   23,437 23,777 24,121 Preferred dividend 1,629   2%   14%   1,426 1,447 1,468 Net income available to common shareholders 20,554   25%   0%   22,011 22,330 22,654 Appendix 7: Projected balance sheets 2018 – 2020 with actual 2017 balance sheet as the base year Consolidated Balance Sheet - USD ($) millions 2017 3-Year Average Common-Size 2-Year Average Trend 2018 2019 2020 Assets Cash and due from banks $23,367   1%   11%   22,719 23,752 24,832 Federal funds sold, securities purchased under resale agreements and other short-term investments 272,605   14%   0%   291,529 304,781 318,636 Trading assets 92,329   4%   19%   83,053 86,829 90,776 Investment securities:             Available-for-sale, at fair value 277,085   15%   3%   306,951 320,904 335,492 Held-to-maturity, at cost 139,335   6%   32%   114,162 119,352 124,778 Mortgages held for sale 20,070   1%   5%   23,724 24,802 25,930 Loans held for sale 108   0%   -18%   172 180 188 Loans 956,770   50%   2%   1,023,132 1,069,643 1,118,268 Allowance for loan losses -11,004   -1%   -2%   (12,251) (12,808) (13,391) Net loans 945,766   50%   2%   1,010,881 1,056,835 1,104,877 Mortgage servicing rights:                   Measured at fair value 13,625   1%   5%   14,038 14,677 15,344 Amortized 1,424   0%   4%   1,489 1,557 1,628 Premises and equipment, net 8,847   0%   1%   9,331 9,755 10,199 Goodwill 26,587   1%   2%   28,385 29,675 31,024 Net amounts in consolidated balance sheet, asset 12,228   1%   -17%   16,088 16,819 17,584 Other assets 118,381   6%   12%   117,959 123,321 128,927 Total assets 1,951,757   100%   5%   2,040,482 2,133,240 2,230,214 Liabilities Noninterest-bearing deposits 373,722   19%   3%   396,495 414,519 433,362 Interest-bearing deposits 962,269   49%   5%   994,781 1,040,003 1,087,280 Total deposits 1,335,991   68%   5%   1,391,276 1,454,522 1,520,643 Short-term borrowings 103,256   5%   3%   107,196 112,069 117,163 Net amounts in consolidated balance sheet, liability 8,796   1%   -18%   13,468 14,081 14,721 Accrued expenses and other liabilities 70,615   3%   10%   67,379 70,442 73,644 Long-term debt 225,020   12%   8%   244,224 255,326 266,933 Total liabilities 1,743,678   89%   5%   1,823,543 1,906,439 1,993,104 Wells Fargo stockholders' equity:                   Preferred stock 25,358   1%   7%   25,941 27,120 28,353 Common stock – $1-2/3 par value, authorized 9,000,000,000 shares; issued 5,481,811,474 shares 9,136   0%   0%   9,879 10,328 10,798 Additional paid-in capital 60,893   3%   0%   65,547 68,527 71,642 Retained earnings 145,263   7%   10%   143,504 150,028 156,848 Cumulative other comprehensive income (loss) -2,144   0%   -594%   (1,740) (1,819) (1,901) Treasury stock – 590,194,846 shares and 465,702,148 shares -29,892   -1%   26%   (25,599) (26,763) (27,980) Unearned ESOP shares -1,678   0%   11%   (1,654) (1,730) (1,808) Total Wells Fargo stockholders' equity 206,936   11%   4%   215,878 225,691 235,951 Non-controlling interests 1,143   0%   14%   1,061 1,109 1,160 Total equity 208,079   11%   4%   216,938 226,800 237,110 Total liabilities and equity $1,951,757   100%   5%   2,040,482 2,133,240 2,230,214 Appendix 8: Projected income statement for 2018 best and worst case scenario USD in millions 2017   5-Year Average   Best Case (5% growth) Worst Case (-5% growth) Revenue             Interest income             Loans and Leases 42,186   46%   41,796 37,816 Other assets 16,723   15%   13,645 12,345 Total interest income 58,909   61%   55,441 50,161 Interest expense             Deposits 3,013   2%   1,677 1,517 Short-term borrowing 758   0%   269 243 Other expense 5,581   4%   3,975 3,596 Total interest expense 9,352   6%   5,921 5,357 Net interest income 49,557   54%   49,521 44,804 Noninterest revenue             Commissions and fees 31,473   40%   36,258 32,805 Lending and deposit-related fees 11,983   17%   15,545 14,064 Securities gains (losses) 2,082   2%   1,717 1,553 Credit card income 3,960   4%   3,943 3,567 Insurance premium 1,049   2%   1,628 1,473 Other income (12,983)   -19%   (17,134) (15,502) Total noninterest revenue 37,564   46%   41,956 37,961 Total net revenue 87,121   100%   91,477 82,765 Provisions for credit losses 2,528   3%       Noninterest expenses             Compensation and benefits 33,371   37%   33,763 30,547 Occupancy expense 2,849   3%   3,122 2,825 Tech, communication and equipment 2,237   2%   2,252 2,038 Other expenses 20,027   18%   16,818 15,217 Total noninterest expenses 58,484   61%   55,956 50,627 Income (loss) from cont. ops before taxes 26,109   36%   32,843 29,715 Provision (benefit) for taxes 4,917   11%   10,017 9,063 Other income (expense) 991   2%   1,432 1,295 Net income 22,183   27%   24,257 21,947 Preferred dividend 1,629   2%   1,476 1,336 Net income available to common shareholders 20,554   25%   22,781 20,612 Appendix 9: Projected balance sheet for 2018 best and worst case scenario Consolidated Balance Sheet - USD ($) millions 2017   3-Year Average Best Case (10% growth) Worst case (-5% growth) Assets           Cash and due from banks $23,367   1% 23,904 20,645 Short-term borrowings 272,605   14% 306,738 264,910 Trading assets 92,329   4% 87,386 75,470 Investment securities:           Available-for-sale, at fair value 277,085   15% 322,964 278,924 Held-to-maturity, at cost 139,335   6% 120,118 103,738 Mortgages held for sale 20,070   1% 24,961 21,558 Loans held for sale 108   0% 181 156 Loans 956,770   50% 1,076,509 929,712 Allowance for loan losses -11,004   -1% (12,891) (11,133) Net loans 945,766   50% 1,063,618 918,579 Mortgage servicing rights:           Measured at fair value 13,625   1% 14,771 12,757 Amortized 1,424   0% 1,567 1,353 Premises and equipment, net 8,847   0% 9,818 8,479 Goodwill 26,587   1% 29,866 25,793 Net amounts in consolidated balance sheet, asset 12,228   1% 16,927 14,619 Other assets 118,381   6% 124,112 107,188 Total assets 1,951,757   100% 2,146,933 1,854,169 Liabilities           Noninterest-bearing deposits 373,722   19% 417,180 360,291 Interest-bearing deposits 962,269   49% 1,046,679 903,950 Total deposits 1,335,991   68% 1,463,858 1,264,241 Short-term borrowings 103,256   5% 112,788 97,408 Net amounts in consolidated balance sheet, liability 8,796   1% 14,171 12,239 Accrued expenses and other liabilities 70,615   3% 70,894 61,227 Long-term debt 225,020   12% 256,965 221,924 Total liabilities 1,743,678   89% 1,918,677 1,657,039 Wells Fargo stockholders' equity:           Preferred stock 25,358   1% 27,294 23,572 Common stock – $1-2/3 par value, authorized 9,000,000,000 shares; issued 5,481,811,474 shares 9,136   0% 10,395 8,977 Additional paid-in capital 60,893   3% 68,967 59,562 Retained earnings 145,263   7% 150,991 130,401 Cumulative other comprehensive income (loss) -2,144   0% (1,830) (1,581) Treasury stock – 590,194,846 shares and 465,702,148 shares -29,892   -1% (26,935) (23,262) Unearned ESOP shares -1,678   0% (1,741) (1,503) Total Wells Fargo stockholders' equity 206,936   11% 227,140 196,166 Non-controlling interests 1,143   0% 1,116 964 Total equity 208,079   11% 228,256 197,130 Total liabilities and equity $1,951,757   100% 2,146,933 1,854,169 Appendix 10: Projected income statement for 2018 factoring in $517 million income from Navy Federal’s MSRs USD in millions 2017 Actual   5-Year Average Trend   4-Year Average Common Size   2018 Pro forma Revenue               Interest income               Loans and Leases 42,186   46%   3%   40,383 Other assets 16,723   15%   13% 13,701 Total interest income 58,909   61%   6%   53,566 Interest expense               Deposits 3,013   2%   33%   1,620 Short-term borrowing 758   0%   138%   260 Other expense 5,581   4%   19%   3,841 Total interest expense 9,352   6%   25%   5,720 Net interest income 49,557   54%   4%   47,846 Noninterest revenue               Commissions and fees 31,473   40%   -2%   35,032 Lending and deposit-related fees 11,983   17%   -8%   15,019 Securities gains (losses) 2,082   2%   47%   1,658 Credit card income 3,960   4%   6%   3,809 Insurance premium 1,049   2%   -12%   1,573 Other income (12,983)   -19%   -7%   (16,554) Total noninterest revenue 37,564   46%   -1%   40,538 Total net revenue 87,121   100%   1%   88,384 Provisions for credit losses 2,528   3%   14%   2,587 Noninterest expenses               Compensation and benefits 33,371   37%   3%   32,621 Occupancy expense 2,849   3%   0%   3,017 Tech, communication and equipment 2,237   2%   3%   2,176 Other expenses 20,027   18%   10%   16,250 Total noninterest expenses 58,484   61%   5%   54,064 Income (loss) from cont. ops before taxes 26,109   36%   -4%   31,733 Provision (benefit) for taxes 4,917   11%   -14%   9,679 Other income (expense) 991   2%   8%   1,383 Net income 22,183   27%   0%   23,437 Preferred dividend 1,629   2%   14%   1,426 Net income available to common shareholders 20,554   25%   0%   22,011  Appendix 11: Projected balance sheet for 2018 factoring in $5.2 billion initial cash outlay to acquire Navy Federals MSRs Consolidated Balance Sheet - USD ($) millions 2017   3-Year Average Trend   2-Year Average Common-Size   2018 Pro forma Assets               Cash and due from banks $23,367   1%   11%   17,519 Short-term borrowings 272,605   14%   0%   291,529 Trading assets 92,329   4%   19%   83,053 Investment securities:               Available-for-sale, at fair value 277,085   15%   3%   306,951 Held-to-maturity, at cost (fair value $138,985 and $99,155) 139,335   6%   32%   114,162 Mortgages held for sale (includes $16,116 and $22,042 carried at fair value) 20,070   1%   5%   23,724 Loans held for sale 108   0%   -18%   172 Loans (includes $376 and $758 carried at fair value) 956,770   50%   2%   1,023,132 Allowance for loan losses -11,004   -1%   -2%   (12,251) Net loans 945,766   50%   2%   1,010,881 Mortgage servicing rights:               Measured at fair value 13,625   1%   5%   19,238 Amortized 1,424   0%   4%   1,489 Premises and equipment, net 8,847   0%   1%   9,331 Goodwill 26,587   1%   2%   28,385 Net amounts in consolidated balance sheet, asset 12,228   1%   -17%   16,088 Other assets (includes $4,867 and $3,275 carried at fair value) 118,381   6%   12%   117,959 Total assets 1,951,757   100%   5%   2,040,482 Liabilities               Noninterest-bearing deposits 373,722   19%   3%   396,495 Interest-bearing deposits 962,269   49%   5%   994,781 Total deposits 1,335,991   68%   5%   1,391,276 Short-term borrowings 103,256   5%   3%   107,196 Net amounts in consolidated balance sheet, liability 8,796   1%   -18%   13,468 Accrued expenses and other liabilities 70,615   3%   10%   67,379 Long-term debt 225,020   12%   8%   244,224 Total liabilities 1,743,678   89%   5%   1,823,543 Wells Fargo stockholders' equity:               Preferred stock 25,358   1%   7%   25,941 Common stock – $1-2/3 par value, authorized 9,000,000,000 shares; issued 5,481,811,474 shares 9,136   0%   0%   9,879 Additional paid-in capital 60,893   3%   0%   65,547 Retained earnings 145,263   7%   10%   143,504 Cumulative other comprehensive income (loss) -2,144   0%   -594%   (1,740) Treasury stock – 590,194,846 shares and 465,702,148 shares -29,892   -1%   26%   (25,599) Unearned ESOP shares -1,678   0%   11%   (1,654) Total Wells Fargo stockholders' equity 206,936   11%   4%   215,878 Non-controlling interests 1,143   0%   14%   1,061 Total equity 208,079   11%   4%   216,938 Total liabilities and equity $1,951,757   100%   5%   2,040,482  Appendix 12: Navy Federal Mortgage Servicing Rights NPV Analysis Principal Value $517,875,724 Gross Rate on Loan 5.20% Service Fee 0.250% Remaining Term (Months) 240 CPR 10 Balloon Months 60 Market Rate for Servicing 6.68% Present Value of Servicing (Price) 0.785260829 Present Value of Servicing (Dollars) $4,066,675 Running head: WELLS FARGO31 Running head: WELLS FARGO1