Walker & Dunlop, Inc. quarterly report, Q2 FY2020

Walker & Dunlop, Inc. — Q2 2020 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2020; comparisons are with the corresponding 2019 periods. Amounts below are in U.S. dollars unless noted. Walker & Dunlop provides commercial real estate finance and services, principally multifamily agency lending, loan servicing, debt brokerage, property sales, and investment management.

Financial performance

Metric	Q2 2020	Q2 2019	Six months 2020	Six months 2019
Revenue	$252.8 million	$200.3 million	$487.0 million	$387.8 million
Operating income	$83.5 million	$57.0 million	$143.8 million	$113.1 million
Net income attributable to Walker & Dunlop	$62.1 million	$42.2 million	$109.9 million	$86.4 million
Diluted EPS	$1.95	$1.33	$3.44	$2.72
Operating margin	33%	28%	30%	29%
Adjusted EBITDA (non-GAAP)	$48.4 million	$62.6 million	$112.5 million	$129.3 million

Q2 revenue rose 26% and net income rose 47% year over year; six-month revenue rose 26% and net income rose 27%.
Q2 adjusted EBITDA declined 23%; six-month adjusted EBITDA declined 13%. The company excludes noncash servicing-right gains from this measure, so its direction differed from GAAP net income.
Growth was led by loan origination fees and fair-value gains on expected servicing cash flows. Q2 origination fees increased 19% and servicing-related fair-value revenue increased 119% year over year. The latter is substantially noncash when recognized.
Q2 expenses rose 18%, including higher personnel costs and credit-loss provisions. Personnel expense increased 27%, with average headcount rising to 860 from 735.

Cash flow, balance sheet, and liquidity

Cash and cash equivalents were $275.2 million at June 30, 2020, compared with $120.7 million at year-end 2019. Including restricted and pledged cash, cash-flow-statement cash totaled $291.9 million.
Six-month operating cash flow was negative $822.6 million, versus negative $159.2 million a year earlier, principally reflecting higher cash tied up in loan originations not yet sold. Excluding loan origination activity, operating cash flow was positive $77.5 million.
Investing cash flow was positive $74.0 million and financing cash flow positive $904.0 million for the six months. Net warehouse borrowings provided $1.01 billion; the company also paid $22.6 million in dividends and repurchased $27.1 million of common stock, including first-quarter program repurchases.
Total assets were $3.79 billion and total liabilities $2.70 billion at June 30. Warehouse notes payable were $1.86 billion, compared with $906.1 million at December 31, 2019. The term-loan principal outstanding was $296.3 million; its balance-sheet carrying amount was $292.8 million.
Warehouse facilities had total capacity of approximately $4.75 billion and outstanding borrowings of approximately $1.86 billion. The facilities fund loans held for sale and investment; warehouse debt rose alongside the larger loan pipeline. The company reported compliance with warehouse and term-loan covenants.
Regulatory/agency operational liquidity was $325.0 million against a stated minimum requirement of $42.9 million. Fannie Mae-defined net worth was $861.6 million against a $216.6 million requirement. The company estimated it would need to fund an additional $68.8 million of DUS pledged securities over 48 months, assuming no portfolio runoff or defaults.

Business changes and material comparisons

Q2 debt-financing volume increased 8% to $6.68 billion, but property-sales volume fell to $446.7 million from $1.10 billion. Total transaction volume declined 2% to $7.13 billion. For the first half, debt-financing volume increased 42% to $16.31 billion and total transaction volume increased 40% to $18.48 billion.
Q2 agency lending benefited from strong Fannie Mae, Freddie Mac, and HUD activity and low interest rates. HUD represented 10% of Q2 debt-financing volume, versus 3% a year earlier. Property sales and non-multifamily brokerage faced COVID-related delays and cancellations.
The servicing portfolio grew to $100.0 billion from $93.2 billion at year-end 2019. Mortgage servicing rights (MSRs) had a net carrying value of $778.3 million, up from $718.8 million. Management shortened the estimated lives of two purchased MSR portfolios by 2.6 years due to faster-than-expected prepayments.
The company acquired assets and assumed certain liabilities from three debt brokerage firms for aggregate consideration of $69.4 million, including $46.8 million cash, $5.0 million stock, and $17.6 million contingent consideration. Goodwill increased by $68.5 million from acquisitions.

Outlook, risks, and unusual items

Management said COVID-19 had not materially affected operations, cash flows, or liquidity through the reporting date, but emphasized uncertainty over the crisis’s duration and economic effects. It cited potential pressure on multifamily occupancy, rents, borrower cash flows, defaults, and servicing advances.
The allowance for risk-sharing obligations was $69.2 million at June 30, compared with $11.5 million at year-end 2019. The CECL reserve for the at-risk Fannie Mae servicing portfolio was $62.3 million, up from $34.7 million on adoption January 1, 2020. Management attributed the increase principally to the COVID-19 forecast; the forecast-period charge-off assumption was raised from one to seven basis points.
Defaulted loans in the at-risk portfolio totaled $48.5 million, or 0.12% of that portfolio, versus $21.0 million and 0.06% a year earlier. The maximum quantifiable contingent exposure under Fannie Mae guarantees was $8.3 billion; the filing cautions this is not an estimate of likely loss.
Fannie Mae and HUD servicing can require the company to advance principal, interest, and fees on delinquent or forborne loans. Advances at June 30 were $1.1 million for Fannie Mae and $4.8 million for HUD. The company expected advance needs could rise if the crisis persisted.
Management temporarily ceased originating new balance-sheet interim loans after the crisis began and described a cautious outlook for that business. It expected agency lending strength to continue, while property-sales activity was expected to recover eventually; these are expectations, not quantified financial guidance.
MSR fair value is sensitive to assumptions: a 100-basis-point increase in the discount rate would reduce estimated fair value by $28.6 million. Escrow earnings and warehouse funding costs are also exposed to interest-rate movements.
The company maintained its quarterly dividend at $0.36 per share and declared the same amount for Q3 2020. It reported no material litigation, no material change in disclosed risk factors, and effective disclosure controls.

Key facts for investors to verify

Whether origination volumes and servicing-related fair-value gains translate into recurring servicing cash flows, and how MSR assumptions and prepayments evolve.
Whether COVID-related multifamily delinquencies, forbearances, and required servicing advances rise, and whether CECL reserves adequately reflect resulting losses.
How much of the negative operating cash flow reflects temporary loan-origination timing, and whether warehouse capacity remains available and renews on acceptable terms.
Whether property-sales and commercial debt-brokerage activity recover, and whether agency lending remains strong amid market and regulatory changes.
The ongoing effects of acquisitions, higher personnel costs, contingent consideration, dividends, and repurchases on earnings, capital, and liquidity.