Walker & Dunlop, Inc. — Q2 2013 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2013. Walker & Dunlop originates, sells and services commercial real estate loans, primarily multifamily, through agency and other investor programs. Results include the effects of the September 2012 CWCapital acquisition, which materially limits year-over-year comparability.
Financial performance
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Revenue | $90.7 million | $46.7 million | $159.9 million | $81.1 million |
| Income from operations | $23.8 million | $15.1 million | $36.1 million | $24.6 million |
| Net income | $14.5 million | $9.3 million | $22.3 million | $15.1 million |
| Diluted EPS | $0.42 | $0.42 | $0.65 | $0.69 |
| Operating margin | 26% | 32% | 23% | 30% |
- Revenue drivers: Mortgage banking gains were $63.1 million in Q2 and $106.0 million for the half, up 86% and 97%, respectively. Servicing fees rose 128% and 127%, to $22.4 million and $43.5 million. Management attributed growth mainly to higher originations, organic growth, and CWCapital.
- Originations and servicing: Originations totaled $2.56 billion in Q2 and $4.29 billion for the half, versus $1.34 billion and $2.01 billion a year earlier. The servicing portfolio reached $37.9 billion at June 30, versus $17.6 billion a year earlier.
- Expenses and margins: Expenses increased 112% in Q2 and 119% for the half, including higher personnel costs and MSR amortization. GAAP operating margins contracted; adjusted margins, a non-GAAP measure excluding specified acquisition-related amortization and lease-modification costs, were 28% in Q2 and 24% for the half, versus 32% and 30%.
- Cash flow: Operating cash flow was $644.2 million for the half, compared with cash used of $140.2 million in 2012. Management said this swing primarily reflected loan originations and sales timing; excluding those loan-purchase and sale flows, operating cash flow was $17.1 million versus negative $9.8 million. Investing used $40.0 million; financing used $602.9 million, chiefly reflecting warehouse-debt repayments. Cash and cash equivalents were $66.3 million at period-end.
- Debt and liquidity: Warehouse notes payable were $485.9 million and term notes payable were $76.8 million at June 30. Total liabilities were $718.2 million and stockholders’ equity was $380.1 million. Warehouse facilities totaled $1.81 billion in maximum capacity; the filing states the company was in compliance with facility covenants. Operational liquidity was $62.2 million against a stated $16.7 million requirement. Management believed available capital and warehouse facilities were adequate for current needs and cash flows sufficient for obligations over the next 12 months.
- Other balance-sheet measures: Loans held for sale were $443.3 million, down from $1.10 billion at year-end 2012; MSRs were $341.8 million on the balance sheet. Fair value of MSRs was $396.3 million. Loans held for investment were $47.2 million; none were delinquent, and no loan-loss allowance was recorded.
Material changes and notable items
- Quarterly revenue rose 94% and six-month revenue rose 97% year over year, while expenses grew faster. Net income increased, but Q2 diluted EPS was unchanged and six-month diluted EPS declined, with substantially higher weighted-average shares outstanding following the acquisition.
- Personnel expense rose 115% in Q2 and 126% for the half; the company added 14 regional offices and 233 full-time employees since June 30, 2012. MSR amortization and depreciation also increased substantially as the servicing portfolio expanded.
- MSR valuation is sensitive to assumptions: a 100-basis-point increase in the discount rate would reduce estimated fair value by $13.1 million; a 200-basis-point increase would reduce it by $25.2 million.
- Fannie Mae revised DUS collateral standards. The company reported compliance and expects to fund $46.8 million of additional restricted liquidity over 48 months. Fannie Mae was to reassess the standards on or before June 30, 2014.
- After quarter-end, a July jury trial in Capital Funding litigation produced a $1.75 million judgment against all defendants and a $10.4 million judgment against Credit Suisse. The plaintiff elected to collect only the latter; final judgment was pending post-trial proceedings and possible appeal. The company said it expected no exposure and believed indemnification covered the judgment.
Outlook, risks, and contingencies
- The filing provides no numerical earnings or revenue guidance. Management described improving multifamily fundamentals and potential lending opportunities from loan maturities, but noted rising interest rates had led some borrowers to delay or reconsider refinancing.
- FHFA directed Fannie Mae and Freddie Mac to reduce 2013 multifamily origination volume by at least 10% from 2012 levels. HUD warned that commitment authority might not cover its pipeline and began prioritizing commitments. Management said the effects on future originations were uncertain and continued to pursue revenue diversification.
- Key risks include changes to or contraction of the GSEs, HUD funding constraints, interest-rate and real-estate market movements, access to warehouse financing, and regulatory changes. A 100-basis-point LIBOR increase was estimated to reduce annual net warehouse interest income by about $2.6 million and annual earnings on corporate debt by about $0.8 million, based on period-end balances.
- Fannie Mae DUS guarantees create credit exposure. The maximum quantifiable contingent liability was $2.9 billion, but the filing emphasizes this is not an estimate of expected loss. The risk-sharing allowance was $12.3 million; 60-day-plus delinquencies within the at-risk portfolio were $9.1 million, or 0.06% of that portfolio.
- The company reported no off-balance-sheet arrangements, no material change in other litigation, and effective disclosure controls. It did not anticipate paying dividends in the foreseeable future.
Investor verification priorities
- Assess how much of the reported growth reflects CWCapital versus organic expansion, and whether higher expenses will continue to pressure margins and per-share results.
- Verify origination trends and revenue mix amid GSE volume limits, HUD commitment prioritization, and rising rates.
- Review MSR valuation assumptions, amortization expectations, and sensitivity to discount rates and prepayments.
- Track the $46.8 million planned DUS collateral funding, warehouse facility maturities and renewals, and compliance with liquidity and debt covenants.
- Monitor DUS delinquencies, allowance adequacy, and the status and outcome of the Capital Funding post-trial proceedings and indemnification.