Walker & Dunlop, Inc. — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015; interim financial statements are unaudited. Walker & Dunlop originates, sells and services commercial real estate loans, principally multifamily, and also provides investment sales brokerage services.
Financial performance and position
Amounts below are in millions of dollars unless otherwise stated.
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Total revenue | $113.9 | $85.3 | $226.0 | $150.1 |
| Operating income | $32.6 | $20.9 | $68.0 | $32.8 |
| Walker & Dunlop net income | $20.2 | $12.9 | $41.5 | $20.1 |
| Diluted EPS | $0.67 | $0.40 | $1.32 | $0.61 |
| Operating margin (company-reported) | 29% | 25% | 30% | 22% |
| Adjusted EBITDA (non-GAAP) | $28.9 | $20.9 | $64.3 | $40.7 |
- Q2 revenue rose 34% year over year; first-half revenue rose 51%. First-half originations increased 97% to $7.82 billion, including growth in GSE and brokered production. Management attributed gains to higher origination volumes, a larger servicing portfolio, and higher warehouse interest income.
- For the first half, gains from mortgage banking activities were $142.7 million, servicing fees $54.9 million, and net warehouse interest income $11.0 million. Costs also increased: personnel expense rose 47% to $86.0 million and amortization/depreciation rose 28% to $48.1 million.
- Return on equity was 20% for Q2 and 19% for the first half, compared with 14% and 10%, respectively, in 2014. Adjusted EBITDA is a non-GAAP measure; the company cautions it is not free cash flow or a substitute for GAAP net income.
Cash flow, debt and liquidity
- First-half operating cash flow was $213.9 million, versus a $355.0 million outflow in 2014. This swing primarily reflects loan origination and sale timing: cash provided by loan-origination activity was $177.5 million, compared with $372.0 million used in 2014. Excluding that activity, operating cash flow was $36.4 million, versus $17.1 million.
- Investing cash outflow was $105.7 million, including $92.0 million net investment in interim loans and $12.8 million for acquisitions. Financing cash outflow was $153.7 million, including $176.5 million net repayment of warehouse notes and $49.7 million of share repurchases. Cash and equivalents declined to $67.8 million from $113.4 million at year-end 2014.
- At June 30, total assets were $1.91 billion, total liabilities $1.47 billion, and total equity $442.8 million. Warehouse notes payable were $1.11 billion and the corporate note payable was $164.6 million. Warehouse facilities totaled $2.10 billion in capacity, with approximately $1.11 billion outstanding; the facilities and corporate debt were subject to covenants, with the company reporting compliance.
- Cash, restricted cash and pledged securities were $67.8 million, $9.2 million and $69.0 million, respectively. Operational liquidity at the operating subsidiary was $69.1 million against a $20.3 million required minimum. The company expects to fund an additional $45.1 million of DUS restricted liquidity over 48 months, assuming no portfolio paydowns, prepayments or defaults.
Material changes and business developments
- The servicing portfolio grew to $47.7 billion from $39.8 billion a year earlier. Interim loans held for investment increased to $314.7 million from $223.1 million at December 31, 2014; loans held for sale declined to $883.3 million from $1.07 billion.
- In April, the company acquired 75% of certain Engler Financial Group assets and liabilities for approximately $13.0 million, entering multifamily investment sales brokerage. The acquired business generated $2.1 million revenue and $0.6 million operating income after acquisition through June 30. The company reported $15.7 million of acquisition goodwill.
- The company increased its CMBS partnership ownership from 20% to 40% in Q2. The change was not material to reported results.
- During Q1, the company repurchased and retired 3.0 million shares at $15.60 per share for $46.8 million. Total first-half repurchases were $49.7 million. Shares outstanding were 29.2 million at June 30; the filing reports 30.5 million outstanding as of July 29.
Outlook, commentary and risks
- No specific full-year financial guidance is provided. Management described commercial and multifamily real estate fundamentals as strong and noted low delinquencies, increasing rents and occupancy, and a refinancing/maturity wave expected during 2015–2017. It expressed optimism about interim lending and plans to expand investment sales brokerage nationally.
- Management cautioned that GSE multifamily production may slow in the second half of 2015 and that tighter future GSE limits could reduce origination-related, non-cash MSR revenue. Competition for loans is intense; competition contributed to lower origination-fee and MSR rates despite volume growth. HUD originations fell 26% year over year in the first half.
- MSRs were carried at $395.0 million; their estimated fair value was $499.8 million. A 100-basis-point increase in the discount rate would reduce estimated MSR fair value by approximately $16.6 million. Valuation depends on assumptions including prepayments, servicing costs and discount rates.
- Fannie Mae DUS risk-sharing creates contingent exposure: the maximum quantifiable guarantee liability was $4.3 billion, which the company says is not representative of expected losses. The risk-sharing allowance was $3.3 million; no at-risk loans were 60 days delinquent at quarter-end. The company also reported no delinquent, impaired or non-accrual interim loans.
- Two matters remain notable: the Capital Funding appeal concerned a $1.8 million judgment, with company exposure said to be capped at $3.0 million by indemnification; and CA Funds Group seeks $5.1 million plus interest and costs, with summary-judgment motions filed in June 2015. No loss reserves were recorded for these matters because management did not consider a loss probable.
- Interest-rate and funding risks include LIBOR sensitivity, warehouse facility renewal and availability, and possible changes in GSE or HUD policies and capital limits. The company reported effective disclosure controls and no material change in internal control over financial reporting.
Key facts for investors to verify
- Whether origination growth and elevated profitability continue if GSE production slows or market competition further compresses fees and MSR rates.
- Cash generation excluding loan funding and sale timing, and the liquidity impact of planned DUS collateral funding and continued interim-loan growth.
- MSR valuation assumptions and sensitivity, including realized prepayments and amortization compared with reported estimates.
- Warehouse facility renewals, utilization, covenant compliance and exposure to rising LIBOR or tighter GSE/HUD requirements.
- Resolution and potential financial impact of the Capital Funding and CA Funds Group litigation, and the effectiveness of related indemnification arrangements.
- Integration and returns from the Engler investment-sales acquisition, including progress toward the stated national expansion strategy.