Walker & Dunlop, Inc. — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011; filed November 10, 2011. The company originates, sells and services commercial real estate loans, primarily multifamily loans, through Fannie Mae, Freddie Mac, HUD and other investors.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $33.4 million | $22.2 million | $104.8 million | $85.8 million |
| Income from operations | $9.7 million | $7.1 million | $38.7 million | $29.5 million |
| Net income | $6.1 million | $7.1 million | $23.8 million | $29.5 million |
| Basic and diluted EPS | $0.28 | $0.48 | $1.10 | $2.00 |
| Operating margin | 29% | 32% | 37% | 34% |
- Revenue drivers: Mortgage banking gains were $21.6 million in Q3 and $69.7 million year to date; servicing fees were $8.8 million and $24.5 million, respectively. Q3 originations rose 104% to $906.7 million; nine-month originations increased 30% to $2.72 billion.
- Expenses and margins: Total expenses rose 57% in Q3 to $23.7 million and 17% year to date to $66.0 million. Personnel costs and amortization increased, reflecting higher production commissions and a larger mortgage-servicing-rights (MSR) portfolio. Q3 operating margin fell, while the nine-month margin improved.
- Taxes and comparability: 2011 net income included income tax expense of $3.6 million in Q3 and $14.9 million year to date. The 2010 predecessor entities were pass-through businesses and recorded no comparable tax expense. On the filing’s pro forma, 38%-taxed basis, 2010 net income was $4.4 million for Q3 and $18.3 million year to date; against those figures, 2011 net income increased 39% and 30%, respectively.
- Cash flow: Nine-month operating cash flow was $213.6 million, versus cash used of $1.8 million in 2010. This was substantially affected by loan originations and sales; excluding those loan purchase-and-sale cash flows, operating cash flow was $7.7 million versus $20.6 million. Investing cash use was $1.7 million; financing cash use was $159.1 million, largely from warehouse debt repayments. Cash and cash equivalents ended at $86.1 million.
- Balance sheet and debt: Total assets were $376.4 million and stockholders’ equity $152.3 million, compared with $485.6 million and $124.6 million at year-end 2010. Loans held for sale declined to $96.3 million from $302.9 million. Warehouse notes payable were $90.1 million and other notes payable $24.8 million; total liabilities were $224.1 million. The term note balance was $24.3 million.
- Servicing and credit: The servicing portfolio grew 13% year over year to $15.9 billion. Fannie Mae 60-plus-day delinquencies were 0.00% of the at-risk portfolio, versus 0.83% a year earlier. The risk-sharing allowance was $13.6 million, up from $7.8 million.
Material changes, outlook and risks
- Management attributed revenue growth to higher originations, servicing-fee growth and $3.4 million of assumption transaction fees in the first nine months, including a $2.5 million fee in Q1. The filing does not provide formal earnings or revenue guidance.
- Management said it expected operating cash flows to cover obligations for the next 12 months and believed warehouse facilities were adequate for current origination needs. It cited gradual economic growth, stabilizing credit quality and potential demand as commercial real estate debt matures. Results may fluctuate with transaction volumes, interest rates and economic conditions.
- In July 2011, the company announced an interim-loan program for multifamily properties, with terms up to two years. No loans had been originated under the program by September 30. A new facility provides up to $35 million, is fully recourse to the company, and is subject to financial covenants and potential early repayment triggers. Management warned that balance-sheet lending exposes the company to greater credit, impairment and interest-rate risks.
- Fannie Mae increased collateral requirements for certain risk-sharing loans. The company estimated approximately $10.4 million of additional collateral would be required over three years based on its September portfolio; Fannie Mae began reassessing collateral adequacy in October, with outcome unknown. Operational liquidity was $85.7 million against a stated $9.0 million requirement; the company reported compliance with debt covenants.
- The maximum quantifiable contingent liability under Fannie Mae DUS guarantees was $1.4 billion, a stress-case maximum rather than an estimate of likely losses. The company’s loss-sharing exposure, allowance estimates and required borrower advances remain relevant risks.
- Capital Funding litigation remained unresolved after an October 27 hearing; the company reported its exposure capped at $3.0 million under an indemnification arrangement, though it could bear significant defense costs pending recovery. Drumm Investors litigation settled October 28: the company received a $1.75 million break-up fee to be recorded in Q4, returned remaining advances and reported no remaining exposure.
- Interest-rate sensitivities disclosed include approximately $2.0 million of annual earnings impact from a 100-basis-point LIBOR move on escrow balances, $0.9 million impact on annual net warehouse interest income, and $0.2 million impact on earnings from corporate debt. A 100-basis-point increase in MSR discount rates would reduce MSR fair value by approximately $4.3 million.
Important facts for investors to verify
- Whether growth in loan production and servicing fees can continue while personnel and MSR amortization expenses rise.
- The quality, assumptions and sensitivity of the $154.0 million estimated fair value of MSRs, including prepayment, discount-rate and servicing-cost assumptions.
- Actual cash generation apart from the timing and volume of warehouse-funded loan originations and sales.
- Future warehouse-facility renewals, covenant headroom, collateral needs and the effect of Fannie Mae’s collateral reassessment.
- Credit performance and ultimate losses on the Fannie Mae risk-sharing portfolio, including the $13.6 million allowance and $1.4 billion stated maximum guarantee exposure.
- Progress, funding and realized credit performance of the interim-loan program, plus the Q4 recognition of the $1.75 million Drumm settlement fee.