Walker & Dunlop, Inc. — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. This is an annual filing, not a standalone fourth-quarter report; selected Q4 results are included below. Dollar amounts are in U.S. dollars.
Business context
Walker & Dunlop provides commercial real estate finance and services, primarily multifamily lending. It originates and sells loans through Fannie Mae, Freddie Mac, and HUD/Ginnie Mae programs, retains servicing rights on most Agency loans, brokers loans for institutional lenders, and offers bridge lending, investment sales, and investment management. The company reported one operating segment.
Financial results and key metrics
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Total revenue | $725.2 million | $711.9 million | +2% |
| Income from operations | $212.9 million | $233.7 million | -9% |
| Walker & Dunlop net income | $161.4 million | $211.1 million | -24% |
| Diluted EPS | $4.96 | $6.47 | -23% |
| Operating margin | 29% | 33% | -4 percentage points |
| Adjusted EBITDA (non-GAAP) | $220.1 million | $201.0 million | +10% |
| Loan originations | $25.3 billion | $24.9 billion | +2% |
| Total transaction volume | $28.0 billion | $27.9 billion | +1% |
| Servicing portfolio, year-end | $85.7 billion | $74.3 billion | +15% |
Revenue growth came mainly from higher servicing fees and escrow earnings, partly offset by lower mortgage banking gains and warehouse income. Mortgage banking gains fell 7% to $407.1 million, primarily as new Fannie Mae servicing fees compressed amid competition and a flattening yield curve. Servicing fees increased 14% to $200.2 million as the average serviced portfolio grew. Escrow and other interest income more than doubled to $43.0 million as balances and short-term rates rose.
Expenses rose 7% to $512.4 million, including higher amortization and depreciation, personnel costs, and other operating expenses. Net income also reflected a higher effective tax rate: 24.4% in 2018 versus 9.3% in 2017, when Tax Reform produced a $58.3 million deferred-tax benefit. The 2018 tax expense included a $2.8 million valuation allowance on certain deferred tax assets. Other operating expenses included a $2.1 million loss on extinguishment of debt.
Fourth quarter: Revenue was $214.9 million, Walker & Dunlop net income was $45.8 million, diluted EPS was $1.41, and transaction volume was $9.35 billion. The filing does not provide a standalone Q4 cash-flow statement.
Cash flow, debt, and liquidity
- Operating cash flow was $64.1 million, versus $1.07 billion in 2017. Management attributed the sharp decline largely to timing of loan originations and sales: loan origination activity used $102.1 million of cash in 2018, compared with a $919.5 million net cash source in 2017. Operating cash flow excluding loan-origination activity was $166.1 million, up from $148.2 million.
- Investing activities used $552.2 million, chiefly reflecting $436.6 million of net investment in loans held for investment, acquisitions, and purchases of pledged securities. Financing activities provided $321.8 million.
- Cash, cash equivalents, restricted cash, and restricted cash equivalents totaled $120.3 million at year-end, down from $286.7 million; unrestricted cash and cash equivalents were $90.1 million. Total assets were $2.78 billion and total equity was $907.2 million.
- Warehouse notes payable were $1.16 billion. The company refinanced its corporate term loan in November 2018 with a $300 million senior secured facility, due November 2025, at 30-day LIBOR plus 225 basis points; carrying value at year-end was $296.0 million. The term loan has quarterly principal installments and covenant restrictions, including restrictions affecting dividends.
- Agency warehouse capacity was reported at $4.42 billion, including $2.365 billion uncommitted capacity; interim warehouse capacity was $260 million. Several bank facilities require annual renewal, and warehouse agreements contain covenants and cross-default provisions.
- At its operating subsidiary, the company reported $123.1 million of operational liquidity against a $34.3 million required minimum, and net worth of $532.7 million against a $174.0 million requirement. It reported compliance with applicable warehouse and term-loan covenants at year-end.
Material changes and unusual items
- Walker & Dunlop acquired JCR Capital in April 2018 for $35.2 million in cash, expanding its investment-management platform. Reported assets under management were $1.42 billion at year-end, including JCR assets. The filing says JCR’s 2018 operating results were immaterial.
- Interim loan originations rose to $993.1 million from $314.4 million. The company held 14 interim loans for investment with $503.5 million outstanding at year-end, including a $150 million participation in a subordinated note. These loans expose the company to direct credit risk; none was delinquent or impaired at year-end.
- Fannie Mae increased the company’s full-risk-sharing cap from $60 million to $200 million per loan, implying maximum loss exposure of $40 million on a single loan under the stated terms. The at-risk servicing portfolio was $32.5 billion; two loans totaling $11.1 million were in default, or 0.03% of that portfolio. The risk-sharing allowance was $4.6 million.
- The company began paying dividends in 2018, declaring $1.00 per share for the year. In February 2019, the board declared a $0.30-per-share first-quarter dividend and authorized a new $50 million repurchase program.
- The company corrected its EPS calculations to apply the two-class method. Corrected 2018 basic and diluted EPS were $5.15 and $4.96; the prior earnings release had reported amounts $0.20 and $0.08 higher, respectively. Prior-year EPS was also corrected. The company stated the errors did not affect net income, equity, or cash flows.
- KPMG issued unqualified opinions on the financial statements and internal control over financial reporting. Management reported effective disclosure controls and internal control; no material litigation was identified.
Outlook, commentary, and risks
Management described multifamily fundamentals as strong, citing rental demand, rent growth, and historically low delinquency rates, and expected continued market strength. It noted that the Federal Reserve raised its target rate by 100 basis points in 2018 and that competition and yield-curve flattening had pressured Fannie Mae servicing fees and warehouse spreads. The company’s stated growth strategy targets at least $1 billion of annual revenue by the end of 2020, supported by $30–$35 billion in annual loan originations, $8–$10 billion in investment sales volume, at least $100 billion in servicing, and $8–$10 billion in assets under management. These are strategic objectives, not a specific 2019 earnings forecast.
Key risks include dependence on Fannie Mae, Freddie Mac, and HUD approvals and programs; uncertainty about GSE reform and loan-purchase caps; renewal and availability of warehouse funding; Fannie Mae risk-sharing and loan repurchase obligations; credit and liquidity exposure from interim lending; interest-rate, competition, and multifamily-market sensitivity; and regulatory, cyber-security, and acquisition-integration risks. Management said the 2019 GSE market-rate multifamily purchase caps were $35 billion per GSE, with specified affordable and underserved-market exclusions. It also cautioned that the impact of natural disasters on affected borrowers could emerge later, despite no material year-end allowance impact identified.
Investor verification priorities
- Review the decline in GAAP net income and operating margin alongside the increase in non-GAAP adjusted EBITDA; assess the impact of lower servicing valuations, higher expenses, and the 2017 tax benefit.
- Check cash-flow quality and liquidity needs, including the $503.5 million interim-loan portfolio, the 2018 decline in total cash, and the continued use and renewal of warehouse facilities.
- Assess GSE policy and counterparty exposure, including the enlarged Fannie Mae risk-sharing cap, the $32.5 billion at-risk portfolio, collateral requirements, and the $59.2 million of additional restricted liquidity expected over four years.
- Verify the sustainability of dividends and buybacks against credit-agreement restrictions, operating cash generation, and capital requirements.
- Review the corrected two-class EPS figures and compare them with previously released figures; the filing states that the correction did not affect net income, equity, or cash flows.
- Track execution against the 2020 growth objectives and the integration and contribution of JCR and other acquisitions.