Walker & Dunlop, Inc. — FY2012 Form 10-K
Reporting period: Fiscal year ended December 31, 2012. This is an annual filing, not a standalone fourth-quarter report; selected Q4 figures are included below. Walker & Dunlop originates, sells and services commercial real estate loans, primarily multifamily, through Fannie Mae, Freddie Mac, HUD/Ginnie Mae and institutional investor programs.
Financial performance and key metrics
| Metric | FY2012 | FY2011 | Change / context |
|---|---|---|---|
| Total revenue | $256.8 million | $152.4 million | Up 69% |
| Mortgage banking gains | $186.5 million | $102.7 million | Up 82%; origination growth was the main driver |
| Servicing fees | $52.2 million | $33.6 million | Up 55% |
| Operating income | $55.8 million | $56.7 million | Down 2% |
| Net income | $33.8 million | $34.9 million | Down 3% |
| Diluted EPS | $1.31 | $1.60 | Down; weighted-average diluted shares increased to 25.8 million from 21.7 million |
| Operating margin | 22% | 37% | Lower amid acquisition, staffing and amortization costs |
| Adjusted operating margin (non-GAAP) | 31% | 37% | Excludes specified acquisition-related costs and acquired intangible amortization |
| Originations | $7.10 billion | $4.03 billion | Up 76% |
| Servicing portfolio | $35.17 billion | $16.78 billion | Up 110%, including acquired portfolio |
FY2012 adjusted net income was $48.4 million and adjusted diluted EPS was $1.87, versus GAAP net income of $33.8 million and diluted EPS of $1.31. These non-GAAP measures exclude acquisition-related severance, acquired-intangible amortization, transition-service fees and deal costs, net of tax effects.
Fourth-quarter 2012 revenue was $105.5 million, operating income $19.4 million, net income $11.5 million, diluted EPS $0.34, and originations $2.91 billion. Quarterly results were affected by the September acquisition and are not directly comparable with prior quarters.
Cash flow, balance sheet and liquidity
- Cash and cash equivalents were $65.0 million at year-end, up from $53.8 million. Operating cash flow was negative $839.2 million, primarily because net loan originations exceeded loan-sale proceeds by $821.9 million. Excluding loan purchases and sales, operating cash flow was negative $17.3 million, compared with positive $18.4 million in 2011.
- Investing cash outflow was $222.1 million, including $208.1 million net cash paid for CWCapital and $9.4 million invested in loans held for investment. Financing cash inflow was $1.073 billion, principally reflecting warehouse and corporate borrowing and acquisition-related share issuance.
- Total assets were $1.689 billion, liabilities $1.335 billion and stockholders’ equity $353.2 million. Loans held for sale were $1.102 billion and warehouse notes payable were $1.085 billion, largely reflecting short-term funding of loans awaiting sale.
- Corporate notes payable were $80.9 million at year-end. The new $83 million term loan matures in 2017, bears interest at one-month LIBOR plus 3.75%, and has quarterly principal amortization. The company reported compliance with warehouse and term-loan covenants at year-end.
- Committed bank warehouse capacity was approximately $1.0 billion, plus a temporary increase, and the company also had a $500 million uncommitted Fannie Mae facility. Several lines mature or require renewal on a short-term basis. Required operational liquidity was $15.4 million; reported operational liquidity was $62.5 million. Management said cash flows and facilities should meet obligations for the next 12 months.
Material changes and unusual items
- CWCapital acquisition: Closed September 4, 2012 for approximately $231.1 million—$80.0 million cash and 11.65 million shares valued at $151.1 million. It added about $14.5 billion to servicing, approximately 180 employees and 14 offices. The acquisition materially increased reported revenue, assets, debt, share count and expenses; FY2012 includes CWCapital only after closing.
- Acquisition-related costs included $15.3 million of acquired-intangible amortization, $3.0 million of transition-services fees and deal-related and severance costs. Management’s unaudited pro forma results, as if the acquisition had occurred January 1, were revenue of $362.4 million and net income of $52.1 million for 2012; the filing cautions that these figures are not indicative of actual results.
- Originations were $7.1 billion, with Fannie Mae at $3.33 billion, Freddie Mac at $1.69 billion and HUD/Ginnie Mae at $855 million. The servicing portfolio included $18.85 billion of Fannie Mae loans and $9.11 billion of Freddie Mac loans.
- Fannie Mae risk-sharing exposure was $13.61 billion; the allowance for risk-sharing obligations was $15.7 million. Delinquencies over 60 days were 0.15% of the at-risk portfolio, down from 0.25%. Net write-offs increased to $6.45 million from $0.68 million in 2011.
Outlook, risks and contingencies
- No specific earnings or revenue guidance is provided. Management described improving multifamily occupancy and rents, but noted that the broader economic recovery remained slow. It expected refinancing activity to increase and identified growth priorities including expanding GSE/HUD originations, capital markets, products and proprietary capital sources.
- GSE reform remains uncertain and is a significant business risk because a substantial majority of originations and servicing derive from Fannie Mae and Freddie Mac. A March 2013 FHFA scorecard directed each GSE to reduce new multifamily business by at least 10% versus 2012 through tighter underwriting, pricing and product limits; further restrictions could reduce company volumes.
- Fannie Mae DUS risk-sharing can expose the company to losses of up to 20% of a loan’s unpaid balance under the standard formula, with higher exposure possible in certain cases. The company also may have to advance borrower payments and meet increasing collateral requirements. Year-end pledged securities and cash were $33.5 million; estimated additional collateral for the existing portfolio was approximately $31.9 million over the applicable funding period.
- Warehouse facilities are essential to funding originations; several are short-term, some capacity is uncommitted, and the agreements include financial covenants and cross-default provisions. Management reported covenant compliance at year-end, but renewal or replacement funding is not assured.
- The new interim-loan program keeps full credit risk on the company’s balance sheet. At year-end it held one such loan with a $9.5 million unpaid balance. This adds credit, funding and execution risks relative to loans pre-sold to investors.
- Capital Funding litigation seeks damages exceeding $30 million on each of several claims. The company states that indemnification limits its damages exposure to $3 million; a trial was scheduled for July 2013. Management could not assure the outcome.
- Interest-rate and valuation sensitivities include an estimated $11.0 million decline in MSR fair value for a 100-basis-point increase in the discount rate. A 100-basis-point LIBOR change would also affect escrow earnings, warehouse interest income and corporate debt costs. Management reported no material effect from Hurricane Sandy.
- The company did not expect to pay cash dividends in the foreseeable future. KPMG issued unqualified opinions on the financial statements and internal controls; management also concluded disclosure controls and internal control over financial reporting were effective at year-end.
Investor verification priorities
- Separate organic growth from CWCapital’s contribution, and assess integration progress, realized synergies and the acquisition’s ongoing costs.
- Reconcile GAAP results with adjusted results, particularly the acquisition exclusions, acquired-intangible amortization and lower reported operating margin.
- Review cash conversion and funding dependence: negative operating cash flow, warehouse balances, facility renewals, uncommitted capacity and covenant headroom.
- Track FHFA/GSE policy changes and their effects on origination volumes, pricing, servicing economics and required collateral.
- Validate risk-sharing allowance assumptions, delinquency and write-off trends, collateral sufficiency and required servicing advances.
- Monitor dilution from the acquisition shares and equity compensation, and the status and indemnification of the Capital Funding litigation.