Walker & Dunlop, Inc. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; comparisons are with Q1 2013 unless stated otherwise. Walker & Dunlop originates, sells, and services commercial real estate loans, primarily multifamily, through GSE and HUD programs, and also brokers loans and holds certain interim loans for investment.
Financial performance and position
| Metric | Q1 2014 / March 31, 2014 | Comparable period / prior year-end |
|---|---|---|
| Total revenue | $64.8 million | $69.2 million; down 6% |
| Income from operations | $11.9 million; 18% operating margin | $12.3 million; 18% margin |
| Net income; diluted EPS | $7.1 million; $0.21 | $7.7 million; $0.23 |
| Adjusted net income; adjusted diluted EPS (non-GAAP) | $7.5 million; $0.22 | $8.5 million; $0.25 |
| Adjusted EBITDA (non-GAAP) | $19.8 million | $13.8 million; up 44% |
| Cash flows from operations | $(74.9) million | $612.0 million provided |
| Cash and cash equivalents | $63.2 million | $170.6 million at December 31, 2013 |
| Loans held for investment, net | $185.6 million | $134.7 million at December 31, 2013 |
| Warehouse notes payable; term note payable | $427.4 million; $172.9 million | $373.1 million; $173.3 million at December 31, 2013 |
| Total liabilities; stockholders’ equity | $764.1 million; $377.5 million | $726.1 million; $402.8 million at December 31, 2013 |
Reported operating margin was unchanged, while adjusted operating margin declined to 19% from 20%. The adjusted measures are non-GAAP; adjusted EBITDA excludes, among other items, non-cash MSR-related gains, and is not a measure of free cash flow.
Material changes and management commentary
- Total loan originations were $1.58 billion, down 9%. Fannie Mae and Freddie Mac originations declined, while HUD/Ginnie Mae originations rose and brokered originations increased 36%. Interim loan originations were $81.3 million, versus none in Q1 2013.
- Mortgage banking gains fell 19% to $34.6 million, mainly due to lower origination volume and a less favorable mix, including lower MSR value created per dollar of originations. Servicing fees rose 10% to $23.3 million as the servicing portfolio grew to $38.9 billion.
- Personnel expense decreased 13% to $24.5 million, reflecting lower commissions and headcount following a 2013 cost-reduction plan. Corporate debt interest expense increased to $2.6 million from $1.0 million, primarily because average debt outstanding was higher.
- Operating cash flow was affected substantially by the timing and funding of loans held for sale: the company reported a $73.6 million net cash use for loan originations, net of loan sales, versus $608.6 million of net cash receipts in Q1 2013. Investing cash use included a $51.5 million net investment in loans held for investment. Financing cash included $35.9 million used to repurchase and retire shares.
- The company repurchased 2.45 million shares from a large stockholder for $14.50 per share, below the market price at the time, and retired them. It reported no intention to pay dividends in the foreseeable future.
Outlook, risks, and contingencies
- Management anticipated continued growth in transitional/interim lending and brokered originations in 2014, and expected to begin originating loans through its CMBS partnership during the year. These are expectations, not formal earnings guidance; the filing provides no specific revenue or earnings forecast.
- Management described improving multifamily fundamentals but increased competition from banks, life insurers, and CMBS lenders. GSE multifamily originations were down 35% year over year through March 31. Management noted that reduced GSE activity could disproportionately lower non-cash MSR revenue and adversely affect results. The future role and structure of Fannie Mae and Freddie Mac remain uncertain.
- Warehouse funding totaled $1.78 billion of facilities, with $427.4 million outstanding. Two committed facilities of $575 million and $650 million were scheduled to mature in September and June 2014, respectively. Fannie Mae reduced its uncommitted line from $500 million to $400 million; the company said it did not expect a significant operational or financial impact. Facility #4 capacity was increased from $100 million to $135 million in April 2014.
- The company reported compliance with debt covenants and stated that its facilities and capital were adequate for current origination needs. It had $118.3 million in operational liquidity at its regulated subsidiary against a $17.2 million requirement, and net worth of $264.8 million against a $90.1 million requirement. It estimated $37.6 million of additional restricted liquidity would be required over 48 months for the DUS portfolio, subject to portfolio performance and future requirements.
- Fannie Mae DUS risk-sharing creates contingent credit exposure: maximum quantifiable exposure was approximately $3.67 billion, which the filing cautions is not representative of expected loss. The related allowance was $5.7 million; there were no 60-day delinquencies in the at-risk portfolio. The interim loan portfolio had no delinquent, impaired, or non-accrual loans at quarter-end.
- Mortgage servicing rights had a $348.0 million carrying value and a separately disclosed estimated fair value of $409.0 million. A 100-basis-point increase in the MSR discount rate would reduce fair value by approximately $13.0 million, underscoring sensitivity to valuation assumptions.
- In the Capital Funding litigation, a $1.8 million judgment was entered against Credit Suisse and affiliates, and Capital Funding appealed. Walker & Dunlop described indemnification arrangements and said it expected no material loss, but noted potential timing and recovery uncertainty. In the separate CA Funds Group case, the court denied the company’s motion to dismiss; the plaintiff seeks a $5.1 million fee plus interest and costs. No loss reserve was recorded for either matter because management did not consider a loss probable.
Important facts for investors to verify
- Whether GSE lending capacity, policy changes, or housing-finance reform alter origination volumes and MSR-related revenue.
- Renewal or extension of near-term warehouse facilities and the effect of collateral and restricted-liquidity requirements on available cash.
- Loan production, interim-loan credit performance, DUS risk-sharing losses, and the basis for the reported contingent exposure and allowance.
- MSR valuation assumptions and sensitivity, particularly discount rates, prepayments, servicing costs, and amortization.
- Developments in both litigations, including the Capital Funding appeal and the CA Funds Group claim, and any change to the company’s loss assessments.
- The drivers and comparability of non-GAAP adjusted EBITDA, given that it increased while GAAP net income and adjusted net income declined.