Walker & Dunlop, Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Walker & Dunlop provides commercial real estate finance and services, with a primary focus on multifamily lending, loan servicing, debt brokerage, property sales, and investment management. Financial amounts below are in millions of dollars unless otherwise noted.
Financial performance and position
| Metric | Q3 2020 | Q3 2019 | Change |
|---|---|---|---|
| Revenue | $247.0 | $212.3 | +16% |
| Income from operations | $69.1 | $59.3 | +17% |
| Walker & Dunlop net income | $53.2 | $44.0 | +21% |
| Diluted EPS | $1.66 | $1.39 | +19% |
| Operating margin | 28% | 28% | Flat |
| Adjusted EBITDA | $45.2 | $54.5 | -17% |
First nine months: Revenue was $734.0 million, up 22%; operating income was $212.9 million, up 24%; net income was $163.1 million, up 25%; and diluted EPS was $5.11 versus $4.11. Adjusted EBITDA declined 14% to $157.7 million. The company defines this non-GAAP measure to exclude, among other items, noncash MSR revenue; it is not a substitute for GAAP earnings or free cash flow.
- Revenue drivers: Q3 origination and debt brokerage fees rose 29% to $83.8 million; fair value of expected servicing cash flows (MSR income) rose 54% to $78.1 million; and servicing fees rose 11% to $60.3 million. YTD MSR income increased 78% to $236.4 million, reflecting higher financing volumes and servicing economics.
- Costs and credit: Q3 personnel expense increased 23% to $114.5 million, partly from higher headcount, commissions, and bonuses. YTD credit-loss provision was $32.0 million versus $2.9 million, principally reflecting CECL estimates for pandemic-related risks.
- Volumes: Q3 debt financing volume was $7.30 billion, approximately flat year over year; YTD volume rose 26% to $23.61 billion. Q3 property sales volume fell 32% to $1.11 billion, while YTD property sales volume fell 4% to $3.28 billion.
- Cash flow: YTD operating cash flow was negative $2.30 billion, primarily because loan originations exceeded loan sales during the period. Investing cash flow was positive $147.6 million and financing cash flow positive $2.34 billion, including $2.50 billion of net warehouse borrowings. The company had $294.9 million of cash and cash equivalents; cash, restricted cash and pledged cash totaled $328.6 million.
- Debt and liquidity: Warehouse notes payable were $3.33 billion at quarter-end, compared with $906.1 million at December 2019, largely reflecting increased loans held for sale. The term loan had $295.5 million principal outstanding (balance-sheet carrying amount $292.3 million), matures in November 2025, and bears interest at 30-day LIBOR plus 200 basis points. The company reported compliance with warehouse and term-loan covenants. It also reported $347.7 million of defined operational liquidity against a $43.9 million minimum requirement.
- Servicing and equity: Servicing portfolio UPB was $103.4 billion, up from $93.2 billion at December 2019. MSRs had an $805.7 million carrying value; a 100-basis-point increase in the discount rate would reduce estimated fair value by $29.1 million. Stockholders’ equity was $1.12 billion.
Material changes versus prior comparable periods
- Higher Agency lending and a more favorable financing mix lifted origination and MSR revenue. The company reported a 12.9% market share with the GSEs for the first nine months.
- The pandemic disrupted property sales and non-multifamily debt brokerage, although both improved from second-quarter lows. Q3 property sales volume remained below the prior-year quarter.
- CECL adoption and revised pandemic-related loss expectations increased the allowance for risk-sharing obligations to $70.5 million from $11.5 million at year-end 2019. The CECL reserve for the at-risk Fannie Mae servicing portfolio was $63.6 million at September 30, compared with $34.7 million at adoption on January 1.
- Three debt brokerage acquisitions added $68.5 million of goodwill; aggregate consideration was $69.4 million, including cash, stock, and contingent consideration. The company also acquired the remaining noncontrolling interest in WDIS, eliminating noncontrolling interests from the balance sheet.
Outlook, risks, and unusual items
- Management said the pandemic had not materially affected company operations, cash flows, or liquidity as of the filing, but emphasized uncertainty. It expected Agency lending strength to continue, citing low rates and the pullback of other capital providers. Property sales had rebounded from Q2 lows, and management anticipated eventual recovery, but gave no quantified earnings or revenue guidance.
- The CARES Act’s supplemental unemployment benefits expired at the end of July 2020, and management noted that sustained unemployment could pressure rent collections, multifamily occupancy, borrower cash flows, delinquencies, and risk-sharing losses. The company had not seen material increases in forbearance requests at filing time.
- Fannie Mae DUS risk-sharing creates contingent exposure. The maximum quantifiable guarantee exposure was $8.5 billion, which the filing says is not representative of expected loss. The CECL estimate uses assumptions about economic conditions, loan runoff, and losses; actual results may differ.
- Servicing advance obligations may increase: advances outstanding were $1.8 million for Fannie Mae and $3.2 million for HUD at September 30. Fannie Mae advances are generally reimbursed after the specified process; HUD advances may remain outstanding until a loan is resolved or assigned.
- Management paused interim loan originations for several months and resumed accepting applications in Q3, while retaining a cautious outlook. One $14.7 million loan held for investment was delinquent and on non-accrual, with a $3.0 million specific reserve. Two defaulted student-housing loans had aggregate specific reserves of $6.9 million.
- Fannie Mae collateral requirements were expected to require $64.5 million of additional pledged securities over 48 months, assuming no portfolio runoff or defaults. The company said it could meet the requirement, while noting future increases could reduce available cash.
- The company paid $0.36 per share in each of the first three quarters and declared the same dividend for Q4. It repurchased 254,000 shares under its 2020 program during Q3 and had $26.3 million of authorization remaining at quarter-end.
- Management expected an effective tax rate of 26%–27% for the remainder of 2020. Ordinary-course litigation was not considered material; the filing reported no material changes to previously disclosed risk factors.
Important facts for investors to verify
- How much of earnings growth is supported by recurring servicing fees versus noncash MSR fair-value revenue, and how sensitive MSR valuations are to discount rates and prepayments.
- Whether pandemic-related deterioration in rents, occupancy, property values, or borrower performance leads to further CECL reserve increases, defaults, or risk-sharing losses.
- Warehouse facility availability, renewal terms, borrowing costs, covenant compliance, and the funding needs associated with elevated loans held for sale.
- The timing and collectability of servicing advances, particularly under HUD arrangements, and any change in borrower forbearance activity.
- Progress in property sales, debt brokerage, and interim lending, as well as the performance and contingent consideration of recent acquisitions.
- Whether cash generation, collateral requirements, and debt restrictions continue to support dividends and share repurchases.