Walker & Dunlop, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Walker & Dunlop provides commercial real estate financing and services, with a primary focus on multifamily lending, alongside loan servicing, investment sales, and investment management.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenue | $178.2 million | $166.4 million | $325.7 million | $324.9 million |
| Income from operations | $53.0 million | $56.1 million | $96.9 million | $112.2 million |
| Walker & Dunlop net income | $41.1 million | $34.6 million | $78.0 million | $77.8 million |
| Diluted EPS | $1.28 | $1.08 | $2.44 | $2.43 |
| Adjusted EBITDA | $50.0 million | $51.0 million | $102.1 million | $101.3 million |
| Operating margin | 30% | 34% | 30% | 35% |
- Q2 revenue rose 7%, while operating income fell 6%; net income increased 19%, aided in part by lower income tax expense. Six-month revenue was nearly unchanged and net income was essentially flat.
- Q2 servicing fees increased 14% to $49.3 million, supported by an 18% increase in average servicing portfolio balances. Mortgage banking gains were nearly unchanged at $102.2 million.
- Six-month mortgage banking gains declined 7% to $183.7 million, primarily reflecting lower Fannie Mae originations. Net warehouse interest income fell 66% to $4.2 million for the half year, amid lower interim-loan balances and narrower loan-sale spreads.
- Personnel expense rose 12% in Q2 and 6% for the six months; other operating expenses increased 31% and 21%, respectively. Management attributed increases to hiring, growth-related costs, and JCR acquisition expenses.
Cash flow, debt and liquidity
- For the six months, operating cash flow was negative $254.2 million, versus positive $420.1 million in 2017. Management attributed the swing mainly to $300.4 million of net cash used in loan origination activity, compared with $380.9 million generated by that activity in 2017. Operating cash flow excluding loan origination activity was positive $46.2 million.
- Investing cash flow was negative $138.6 million; financing cash flow was positive $275.9 million, including $323.2 million of net warehouse borrowings. Cash, cash equivalents, restricted cash, and restricted cash equivalents totaled $169.8 million at period-end. Separately, balance-sheet cash was $81.5 million and restricted cash was $30.0 million; pledged securities were $105.8 million.
- Warehouse notes payable were $1.251 billion and the term note payable was $163.7 million at June 30. Warehouse facilities had $5.28 billion of total stated capacity, including substantial uncommitted capacity. The term loan matures in December 2020; warehouse facilities are short-term and several were scheduled to mature in 2018 or 2019.
- The company reported $117.2 million of operational liquidity against a $31.9 million requirement, and $664.9 million of defined net worth against a $161.9 million requirement. It was in compliance with warehouse, term-loan, and Agency covenants.
- Fannie Mae collateral requirements are expected to require an additional $64.2 million of pledged securities over 48 months, assuming no portfolio paydowns, prepayments, or defaults. Management said future changes to requirements could reduce available cash.
Material changes and business developments
- Total loan origination volume was $5.71 billion in Q2, approximately flat year over year; first-half volume was $10.22 billion, down about 2%. Q2 interim originations increased sharply to $192.2 million from $26.6 million, while first-half interim originations rose to $216.9 million from $163.2 million.
- The servicing portfolio grew to $77.8 billion from $74.3 billion at December 31, 2017. Investment sales volume increased 37% in Q2 and 28% for the first half.
- In April, the company acquired JCR Capital for $35 million in cash to expand investment management. JCR reported $813.2 million of assets under management; the company reported total managed assets of $932.3 million. Purchase accounting remained subject to tax information and working-capital adjustments.
- The board initiated a quarterly dividend in 2018: $0.25 per share for each of the first two quarters and declared another $0.25 for Q3. A $50 million repurchase authorization remained unused at June 30; the company had repurchased shares under an earlier program during the first half.
Outlook, risks and contingencies
- Management expected continued strength in multifamily markets and anticipated continued growth in its capital-markets and investment-sales platforms. It expected most qualifying future interim loans to be originated through the joint venture, which could reduce net warehouse interest income from loans held for investment, partly offset by the company’s share of JV earnings.
- The filing provides no specific full-year revenue or earnings guidance. Management expected the 2018 annual effective tax rate to remain near 25.7% and did not expect significant excess tax benefits in the rest of 2018.
- Risks include intense competition, higher short-term rates and a flatter yield curve compressing warehouse spreads, changes in GSE lending limits or policy, and dependence on renewing or maintaining warehouse funding. The 2018 GSE origination caps were $35 billion each for Fannie Mae and Freddie Mac for market-rate apartments.
- Fannie Mae increased the company’s risk-sharing cap from $60 million to $200 million. The maximum loss exposure on an individual loan can be $40 million under the stated terms. The $6.2 billion maximum quantifiable contingent liability across the guaranteed portfolio is a theoretical maximum, not an estimate of expected loss. One loan was 60 or more days delinquent, with a balance of approximately $6.0 million; the filing reported no historical delinquencies or charge-offs on interim loans held for investment.
- MSR values are sensitive to discount-rate assumptions: a 100-basis-point increase in the discount rate would reduce estimated MSR fair value by $28.4 million. Ordinary-course litigation was described as not material; management reported no material changes to the risk factors in the 2017 Form 10-K.
- The company expected the new lease standard, effective January 1, 2019, to increase balance-sheet assets and liabilities but have an immaterial income-statement impact. It expected the expected-credit-loss standard, planned for adoption in 2020, to increase the risk-sharing allowance; the financial impact was still under evaluation.
Investor facts to verify
- Whether the increase in servicing revenue and portfolio growth can offset lower mortgage banking gains and warehouse spreads.
- How much warehouse capacity is committed versus uncommitted, and the status and terms of facilities approaching maturity.
- Actual future cash demands from Fannie Mae collateral requirements and the higher risk-sharing cap.
- JCR’s realized fee and incentive contribution, subsequent purchase-price adjustments, and the conversion of reported AUM into revenue.
- MSR valuation assumptions, prepayment experience, and credit performance of the delinquent DUS loan and broader risk-sharing portfolio.