Walker & Dunlop, Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. Walker & Dunlop originates, sells and services commercial real estate loans, primarily multifamily, and also provides investment-sales brokerage. Amounts below are in millions unless stated otherwise.
Financial results
| Metric | Q2 2016 | Q2 2015 | H1 2016 | H1 2015 |
|---|---|---|---|---|
| Total revenue | $147.9 | $113.9 | $242.1 | $226.0 |
| Income from operations | $51.7 | $32.6 | $75.9 | $68.0 |
| Walker & Dunlop net income | $32.0 | $20.2 | $47.5 | $41.5 |
| Diluted EPS | $1.05 | $0.67 | $1.55 | $1.32 |
| Operating margin | 35% | 29% | 31% | 30% |
| Adjusted EBITDA (non-GAAP) | $27.1 | $28.9 | $59.5 | $64.3 |
Q2 revenue rose 30% and net income 59%, led by higher mortgage-banking gains and servicing fees. Gains from mortgage banking increased 46% to $102.5 million; servicing fees rose 17% to $32.8 million. H1 revenue increased 7% and net income 15%, while adjusted EBITDA declined 7%. Management’s EBITDA measure excludes noncash MSR-related gains, among other adjustments; it is not a substitute for GAAP results or free cash flow.
- Origination and transactions: Q2 loan originations were $4.77 billion, up 37% year over year. H1 originations were $7.22 billion, down 8%; total H1 transaction volume was $8.00 billion, versus $8.14 billion. H1 investment-sales volume increased to $780.9 million from $319.0 million.
- Cash flow: H1 operating cash flow was $321.5 million, investing cash flow was negative $53.9 million, and financing cash flow was negative $343.6 million. Operating cash flow was materially affected by timing of loan originations and sales; excluding loan-origination activity, operating cash flow was negative $6.6 million. Cash and cash equivalents fell to $61.0 million from $137.0 million at year-end 2015.
- Balance sheet and debt: Total assets were $3.30 billion and equity was $538.1 million at June 30. Warehouse notes payable were $2.34 billion; the term note’s stated principal balance was $167.9 million. Loans held for sale were $2.24 billion. Debt and warehouse facilities are subject to covenants, and the company reported compliance at quarter-end.
- Liquidity: The operating subsidiary reported $107.9 million of operational liquidity against a $21.2 million requirement. The company expects to fund an additional $45.9 million of restricted liquidity for Fannie Mae DUS obligations over 48 months, assuming no portfolio changes. It reported $61.0 million in cash, plus $17.6 million restricted cash and $78.5 million pledged securities; these balances are not all freely available.
- Servicing and credit: The servicing portfolio reached $57.3 billion, up from $47.7 billion a year earlier. No risk-sharing loans were 60 or more days delinquent, and interim loans were reported as current, unimpaired and on accrual. The risk-sharing allowance was $5.8 million.
Material changes and notable items
- Effective January 1, 2016, Walker & Dunlop assumed full ownership of and began consolidating its CMBS program, affecting reported loans held for sale, warehouse debt and mortgage-banking gains.
- In June, the company purchased servicing rights on a HUD portfolio with approximately $3.8 billion of unpaid principal balance for $44.8 million. The portfolio’s estimated remaining life was 10.8 years. MSRs on the balance sheet were $468.1 million; their estimated fair value was $576.4 million. A 100-basis-point increase in the MSR discount rate would reduce estimated fair value by $18.6 million.
- The company repurchased approximately 0.4 million shares during H1 for $9.2 million under its $75 million authorization; $65.8 million remained authorized at quarter-end. It paid no common dividends.
- Management cited higher staffing, commissions and MSR amortization as contributors to expense growth. Q2 personnel expense rose 21% and amortization and depreciation rose 13% year over year.
Outlook, risks and contingencies
The filing provides no numerical earnings or revenue guidance. Management described multifamily fundamentals as strong and expected low interest rates and loan maturities to support lending and investment-sales activity, while noting uncertainty about the duration of market effects. The FHFA raised the 2016 Fannie Mae and Freddie Mac multifamily caps to $35 billion each. Management said H1 GSE originations were down 13% year over year; brokered originations were up 10%, interim originations increased, and HUD and CMBS activity weakened. It viewed its capital-markets outlook positively but noted fierce competition and lower CMBS demand.
- Brexit had minimal direct operational impact; management said potential indirect effects were uncertain and could include both lower rates and greater investor demand, as well as wider credit spreads.
- Key business risks include interest-rate and credit-spread movements, competition, access to warehouse funding, dependence on GSE and HUD programs, and changes in regulation or GSE production limits. Temporary increases in certain warehouse lines were due to expire in August or September 2016; the filing also describes subsequent facility changes.
- Fannie Mae DUS guarantees had a maximum quantifiable contingent exposure of $4.3 billion. The filing stresses this is a hypothetical maximum, not an estimate of expected loss. The company also had $36.4 million of unfunded preferred-equity commitments, expected to be funded over 12–24 months.
- Management reported no material pending litigation and no material change to the risk factors in the 2015 Form 10-K. The company was evaluating the impact of a new expected-credit-loss accounting standard, effective in 2020 unless adopted early.
Important facts for investors to verify
- Whether mortgage-banking gains and earnings growth are sustained as loan volume and the mix of Fannie Mae, HUD, brokered and CMBS originations change.
- How much reported profitability depends on noncash MSR valuations, and the sensitivity of MSR value and amortization to discount rates and prepayments.
- Warehouse-line availability, temporary capacity extensions and renewals, borrowing costs, and covenant headroom.
- Actual credit performance and potential losses under DUS risk-sharing, compared with the large stated maximum contingent exposure.
- Whether cash generation remains adequate after loan-funding needs, restricted-liquidity requirements, servicing-portfolio investments and preferred-equity commitments.