Walker & Dunlop, Inc. — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012. Walker & Dunlop is a commercial real estate finance company focused primarily on multifamily lending, originating, selling and servicing loans through Fannie Mae, Freddie Mac, HUD/Ginnie Mae and other investors.
Financial performance
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Total revenue | $34.4 million | $29.0 million | +19% |
| Operating income | $9.5 million | $10.9 million | -13% |
| Net income | $5.8 million | $6.6 million | -12% |
| Diluted EPS | $0.27 | $0.31 | Lower |
| Operating margin | 28% | 37% | -9 percentage points |
| Operating cash flow | $(21.4) million | $182.4 million | Down materially |
Revenue growth reflected 33% higher loan originations ($674.5 million) and 22% higher servicing fees. Mortgage banking gains were $19.8 million (+18%); servicing fees were $9.4 million; net warehouse interest income was $0.9 million. Expenses rose 37% to $24.9 million, including personnel expense of $11.6 million (+26%), amortization and depreciation of $7.3 million (+48%), and other operating expenses of $4.6 million (+53%). Management attributed the margin decline to platform growth, higher MSR amortization including a $1.1 million write-off, and increased risk-sharing provision.
Financial position, liquidity and debt
At March 31, 2012, cash and cash equivalents were $40.8 million, down from $53.8 million at year-end 2011. Total assets were $517.5 million and stockholders’ equity was $170.0 million. Warehouse notes payable were $236.7 million and other notes payable were $23.0 million. Warehouse borrowing availability comprised $535 million of committed facilities and a $250 million uncommitted Fannie Mae facility; borrowings totaled $236.7 million. The company reported compliance with warehouse covenants.
Cash used in operations was primarily affected by the timing of loan originations and sales; excluding those loan flows, operating cash use was $14.7 million. Investing cash use was $8.9 million, including $6.9 million funded for the first interim loan and increased capital expenditures. Financing provided $17.2 million. Management stated cash flows from operations should meet current obligations for the next 12 months. Required operational liquidity was $9.2 million versus reported operational liquidity of $40.5 million. No dividend is anticipated in the foreseeable future.
Material changes and notable items
- Originations increased to $674.5 million from $507.5 million. “Other” originations, including commercial banks, life insurers, CMBS and interim loans, grew substantially; GSE and HUD originations represented 69% of the total versus 86% a year earlier.
- The servicing portfolio rose 13% to $16.9 billion. Mortgage servicing rights (MSRs) had a $142.6 million carrying amount; estimated fair value was $164.0 million. A 100-basis-point increase in the MSR discount rate would reduce estimated fair value by about $4.7 million.
- The company made its first interim loan in February 2012; interim loans are held for investment and expose the company to the full credit risk while outstanding.
- A warehouse agreement was amended in March: its commitment increased from $150 million to $350 million, maturity extended to February 28, 2013, and the borrowing spread reduced from LIBOR plus 200 to plus 185 basis points. An unlimited master purchase and sale agreement expired March 16, 2012.
- Other revenue included a $2.5 million benefit from amending a fee-allocation agreement with Credit Suisse. A large portfolio prepayment led to the $1.1 million MSR write-off; the company did not share in related prepayment penalties.
Outlook, risks and contingencies
Management described improving multifamily occupancy and rents, while noting the broader real estate recovery remained constrained by the slow economic recovery. It expected GSE and HUD programs to remain significant sources of multifamily capital in 2012, but cited uncertainty about GSE reform, regulation and Dodd-Frank. The filing provides no specific financial earnings or revenue guidance.
- Fannie Mae risk-sharing allowance was $14.5 million; the maximum quantifiable contingent liability under DUS guarantees was $1.6 billion, which the company emphasized is not a measure of expected loss. The 60-day delinquency rate on the at-risk portfolio fell to 0.08% from 0.48% a year earlier; the quarter included $1.6 million of net write-offs.
- Fannie Mae collateral changes were expected to require approximately $17.9 million of incremental collateral over the life of the existing portfolio. Management said the currently affected loan count was insignificant and expected no material impact, while warning future changes could adversely affect the business.
- Capital Funding litigation remained in discovery, with trial scheduled for July 9, 2012. The company stated its loss exposure was capped at $3.0 million under an indemnification arrangement, but it could bear litigation costs pending recovery under that arrangement.
- Interest-rate sensitivity: a 100-basis-point LIBOR increase was estimated to increase annual escrow earnings by $2.9 million, reduce annual net warehouse interest income by $2.4 million, and reduce annual earnings on corporate debt by $0.2 million. Interim loan income and related funding costs were described as offsetting.
- Warehouse funding availability, GSE/HUD policy and collateral requirements, loan defaults and prepayments, and MSR valuation assumptions remain material business risks.
Investor verification points
- Reconcile revenue growth with lower net income and the substantial increase in personnel, amortization and other operating costs.
- Assess operating cash use in light of loan origination/sale timing and the company’s stated 12-month liquidity outlook.
- Review warehouse facility renewal, utilization and covenant terms, including the expired master agreement and amended facility.
- Evaluate DUS risk-sharing exposure, delinquency trends, allowance adequacy and expected collateral requirements.
- Check the outcome and costs of the Capital Funding litigation and the enforceability and timing of indemnification.
- Monitor interim lending growth and credit performance, and the assumptions underlying MSR fair values and prepayment risk.