Walker & Dunlop, Inc. annual report, FY2013

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Walker & Dunlop, Inc. — 2013 Form 10-K Summary

Reporting period: Fiscal year ended December 31, 2013; filing dated March 7, 2014. Amounts below are in U.S. dollars. The filing is an annual report, with selected fourth-quarter results also disclosed.

Business context

Walker & Dunlop originates, sells, and services commercial real estate loans, primarily multifamily. Its business relies significantly on Fannie Mae, Freddie Mac, and HUD programs; it also brokers loans for institutional investors and offers interim and bridge lending. The company generally retains servicing rights on loans it originates for the GSEs and HUD and bears loss-sharing risk on many Fannie Mae loans.

Financial performance and key metrics

  • Revenue: $319.0 million, up 24% from $256.8 million in 2012. Mortgage banking gains were $203.7 million (+9%); servicing fees were $90.2 million (+73%).
  • Profit: Operating income was $66.8 million, up 20%; net income was $41.5 million, up 23%. Diluted EPS was $1.21, down from $1.31, reflecting a larger weighted-average share count after the CWCapital acquisition. Operating margin declined to 21% from 22%.
  • Adjusted measures: Adjusted net income was $44.0 million versus $48.4 million; adjusted diluted EPS was $1.28 versus $1.87; adjusted operating margin was 22% versus 31%. Adjusted EBITDA was $56.8 million versus $29.4 million. These are company-defined non-GAAP measures and are not substitutes for GAAP results.
  • Originations and servicing: Loan originations totaled $8.4 billion, up 18%. The servicing portfolio reached $38.9 billion, up 11% year over year; the average portfolio increased substantially due partly to CWCapital. GSE and HUD originations represented 53% of 2013 originations, compared with 71% in 2012.
  • Fourth quarter: Revenue was $85.5 million versus $105.5 million in Q4 2012; operating income was $18.0 million versus $19.4 million; net income was $11.2 million versus $11.5 million. Originations were $2.34 billion versus $2.91 billion.
  • Cash flow: Operating cash flow was $836.9 million, compared with cash used of $839.2 million in 2012. The swing primarily reflects timing and volume of loans originated and sold; excluding net loan-purchase and sale cash flows, operating cash flow was $39.2 million versus cash used of $17.3 million. Investing cash use was $130.6 million; financing cash use was $600.7 million.
  • Liquidity and balance sheet: Cash and cash equivalents were $170.6 million, versus $65.0 million. Total assets were $1.129 billion and equity was $402.8 million. The company reported $166.9 million of operational liquidity at its operating subsidiary against a stated minimum requirement of $17.4 million; $49.7 million of securities and cash were pledged as collateral.
  • Debt: Year-end warehouse notes payable were $373.1 million and notes payable were $173.3 million. The company replaced its prior $83.0 million term loan with a $175.0 million secured term loan in December 2013, due December 2020; the outstanding balance was $173.3 million and the stated current rate was LIBOR plus 4.50%. Warehouse facilities totaled $1.4 billion committed, plus a $500 million uncommitted Fannie Mae facility. The company reported covenant compliance at year-end.
  • Credit exposure: The Fannie Mae at-risk servicing balance was $15.1 billion; 60+-day delinquencies were 0.02% of that balance, versus 0.15% in 2012. The risk-sharing allowance was $7.4 million. Interim loans held for investment totaled $134.7 million; the company reported no delinquencies or losses on those loans through year-end.

Material changes versus 2012

  • Results include a full year of CWCapital, acquired in September 2012; 2012 included only four months, limiting direct comparability. The acquisition expanded the servicing portfolio by $14.5 billion and added origination capacity.
  • Servicing fees and mortgage banking revenue rose with portfolio and origination growth, while expenses also increased: personnel expense rose 23% and amortization and depreciation rose 88%. GAAP operating margin and adjusted operating margin both weakened.
  • GSE and HUD origination conditions were less favorable. The FHFA directed Fannie Mae and Freddie Mac to reduce multifamily production, and HUD temporarily exhausted commitment authority in 2013. Competition from banks, life insurers, and CMBS lenders also increased.
  • The company expanded brokered and proprietary lending, launched a large bridge-loan partnership, and formed a CMBS partnership. Its own interim-loan balance grew to $134.7 million; the CMBS program had not originated loans by year-end.
  • In October 2013, the company eliminated 52 positions and shut down its small-loan lending program, expecting annual savings above $7 million. It recorded $0.7 million of fourth-quarter severance and lease charges.

Outlook, risks, contingencies, and unusual items

  • Management described improving multifamily fundamentals and potential loan demand from property maturities, but provided no specific financial guidance. It said future GSE production limits and GSE reform remained uncertain and that it was diversifying lending sources and products.
  • Key risks include dependence on GSE and HUD programs and approvals; Fannie Mae risk-sharing and servicing advances; renewal and availability of warehouse funding; interest-rate, commercial real estate, and market-cycle exposure; and competition, regulation, and potential loan repurchase or indemnification obligations.
  • Increased Fannie Mae collateral requirements were expected to require a further $40.9 million of restricted liquidity over 48 months, assuming no portfolio paydowns, prepayments, or defaults. Future collateral changes could constrain available cash.
  • Two lawsuits were disclosed. In the Capital Funding matter, a $10.4 million judgment against Credit Suisse was vacated in January 2014 and a $1.75 million contract judgment remained; the plaintiff sought a new trial. Walker & Dunlop said its exposure was capped at $3 million by an indemnification arrangement and believed the judgment was covered. CA Funds Group sought $5.1 million plus interest and costs in a separate dispute; the company intended to defend the case and had not recorded a loss reserve, stating loss was not probable.
  • Unusual 2013 items included a $1.2 million loss on extinguishment of debt and a $1.8 million servicing termination fee. No cash dividends were planned for the foreseeable future. Management and the auditor reported effective disclosure controls and internal control over financial reporting; KPMG issued unqualified opinions on the financial statements and internal controls.

Important facts for investors to verify

  • Whether GSE multifamily lending limits, GSE reform, or HUD funding constraints further affect originations, revenue, and servicing growth.
  • How much of earnings growth is recurring, given lower margins, elevated expense growth, non-GAAP adjustments, and the full-year acquisition contribution.
  • Warehouse facility renewals, covenant headroom, term-loan leverage and interest costs, and the effect of collateral requirements on unrestricted liquidity.
  • Credit performance and loss exposure in Fannie Mae risk-sharing loans and the growing balance-sheet interim-loan portfolio; distinguish the disclosed maximum exposure from expected losses.
  • Developments in both lawsuits, including the Capital Funding post-judgment motion and the CA Funds Group claim, and any resulting cash or earnings impact.