Walker & Dunlop, Inc. — Q3 2015 Form 10-Q
Reporting period: Three and nine months ended September 30, 2015; filed November 4, 2015. Dollar amounts below are in millions unless stated otherwise. Walker & Dunlop originates, sells and services commercial real estate loans, primarily multifamily, and provides investment sales brokerage services.
Financial performance
| Metric | Q3 2015 | Q3 2014 | 9M 2015 | 9M 2014 |
|---|---|---|---|---|
| Total revenue | $120.8 | $98.1 | $346.8 | $248.2 |
| Operating income | $33.4 | $24.5 | $101.5 | $57.3 |
| Walker & Dunlop net income | $20.3 | $15.1 | $61.7 | $35.2 |
| Diluted EPS | $0.66 | $0.47 | $1.99 | $1.08 |
| Adjusted EBITDA (non-GAAP) | $31.0 | $20.7 | $95.3 | $61.4 |
| Operating margin (company-reported) | 28% | 25% | 29% | 23% |
- Nine-month revenue increased 40% and net income attributable to Walker & Dunlop rose 75% year over year. Loan origination volume grew 68% to $11.9 billion; total transaction volume, including investment sales, was $13.1 billion.
- Q3 revenue grew 23% and net income rose 34%. Growth reflected mortgage banking gains, a larger servicing portfolio, higher net warehouse interest income, prepayment fees and new investment sales revenue. Personnel costs and amortization also increased.
- Mortgage servicing rights (MSRs) were carried at $404.0 million, compared with $375.9 million at year-end 2014. The estimated fair value was $500.7 million; a 100-basis-point increase in the discount rate would reduce that fair value by an estimated $16.7 million.
- For the nine months, net cash provided by operating activities was $9.2 million, versus cash used of $471.9 million in 2014. The comparison was heavily affected by the timing of loans originated and sold: operating cash flow excluding loan-origination activity was $39.1 million versus $23.7 million. Investing activities used $136.1 million, chiefly reflecting a $122.0 million net investment in loans held for investment and $12.8 million for acquisitions. Financing activities provided $73.7 million.
Balance sheet, debt and liquidity
- At September 30, 2015, cash and cash equivalents were $60.2 million, down from $113.4 million at December 31, 2014; total assets were $2.17 billion and total equity was $466.9 million.
- Warehouse notes payable were $1.338 billion and the term note payable was $164.5 million, for approximately $1.503 billion in these borrowings. Warehouse facilities had stated maximum capacity of $2.36 billion. Warehouse and corporate debt carried variable-rate exposure, primarily tied to LIBOR.
- Management reported $71.4 million of operational liquidity at its operating subsidiary against a $20.5 million requirement, and $429.4 million of net worth against a $106.9 million Fannie Mae requirement. The company was in compliance with applicable debt covenants at quarter-end.
- Fannie Mae DUS requirements were expected to require an additional $44.3 million of restricted liquidity over 48 months, assuming no portfolio paydowns, prepayments or defaults.
- Repurchased and retired 3.0 million shares in Q1 for $46.8 million; total nine-month repurchases were $50.1 million. The company did not pay dividends.
Material changes and management outlook
- Fannie Mae and Freddie Mac originations rose substantially, as did brokered originations; HUD originations fell 28% year over year for the first nine months to $416.9 million. Interim loan originations declined to $145.0 million from $229.9 million.
- The company completed its acquisition of 75% of certain Engler Financial Group assets in April and launched investment sales brokerage services. The business closed $1.1 billion of investment sales during its first two quarters. The company also increased its CMBS Partnership ownership from 20% to 40% in Q2.
- Management described commercial and multifamily real estate fundamentals and demand as strong, citing increased refinancing activity and a wave of loan maturities expected through 2017. It considered the outlook positive for its capital markets platform and intended to expand investment sales nationally. No quantitative earnings guidance was provided.
- Management noted that the FHFA maintained $30 billion market-rate multifamily caps for each GSE for 2016, with periodic review and possible upward adjustment; future GSE limits remain uncertain. Competition among banks, insurers, GSEs and CMBS lenders was described as intense.
- The company had committed $42.8 million to preferred equity investments, none funded as of quarter-end, with funding expected over 18–36 months beginning in Q4 2015. Management cautioned these investments are subordinate to debt and generally not secured by real estate.
Risks, contingencies and unusual items
- Fannie Mae DUS risk-sharing exposure is significant: the maximum quantifiable contingent liability was $3.9 billion, a stress-case amount rather than an estimate of expected loss. No loans in the at-risk portfolio were 60 days delinquent at quarter-end; the risk-sharing allowance was $3.3 million.
- Two litigations remained pending. In Capital Funding litigation, a $1.8 million judgment was on appeal; the company said its exposure was capped at $3.0 million under an indemnification arrangement and believed the judgment would be covered. In CA Funds Group litigation, the plaintiff sought $5.1 million plus interest and costs; summary judgment motions were pending, with a ruling expected in Q1 2016. No loss reserve was recorded for either matter because management did not consider a loss probable.
- MSR valuations rely on assumptions about discount rates, prepayments and servicing costs; faster prepayments or adverse valuation changes may increase amortization or write-offs. The company reported increased MSR write-offs from prepayments during 2015.
- Warehouse financing is essential to loan originations, and facility agreements include cross-default provisions. Several facility amendments and temporary capacity increases were disclosed after quarter-end; investors should check the filing’s subsequent-period disclosures for their terms and expirations.
- Management said results may fluctuate with interest rates, transaction volumes, acquisitions, regulation and economic conditions. The filing also identifies uncertainty around GSE/HUD funding and policies, market competition, liquidity needs and preferred equity commitments.
Key facts for investors to verify
- How much of reported earnings growth is supported by recurring servicing income versus noncash MSR gains, prepayment fees and other items.
- Whether cash conversion improves as loan origination and sale activity changes; quarter-end cash fell materially despite positive nine-month operating cash flow.
- MSR valuation assumptions and sensitivity, including prepayment behavior and discount rates.
- Fannie Mae risk-sharing exposure, collateral funding requirements and the potential effect of GSE lending caps or policy changes.
- Renewal, maturity and availability of warehouse facilities, including subsequent-quarter amendments and cross-default implications.
- Progress and risk controls for the $42.8 million preferred equity commitment, and outcomes of the two pending legal matters.
- Performance and profitability of the newly acquired investment sales business and other expansion initiatives.