Walker & Dunlop, Inc. — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. Walker & Dunlop finances commercial real estate, primarily multifamily, by originating, selling and servicing loans through Fannie Mae, Freddie Mac and HUD programs, as well as brokering loans and originating interim loans.
Financial performance and position
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Revenue | $85.3m | $90.7m | $150.1m | $159.9m |
| Income from operations | $20.9m | $23.8m | $32.8m | $36.1m |
| Net income | $12.9m | $14.5m | $20.1m | $22.3m |
| Diluted EPS | $0.40 | $0.42 | $0.61 | $0.65 |
| Operating margin | 25% | 26% | 22% | 23% |
- Q2 revenue declined 6% and net income 11% year over year; six-month revenue declined 6% and net income 10%.
- Mortgage banking gains fell 17% in Q2 to $52.2m and 18% for the half to $86.8m, reflecting lower originations and lower servicing-rights value recognized on new production. Servicing fees rose 7% in Q2 and 9% for the half; net warehouse interest income rose to $3.9m and $6.1m, respectively.
- Total originations were $2.39bn in Q2, down from $2.56bn, and $3.97bn for the half, down from $4.29bn. Interim loan originations increased to $147.1m for the half from $37.9m.
- Expenses declined 4% in Q2 and 5% for the half, primarily due to lower personnel costs and operating expenses. Corporate-debt interest expense increased to $2.6m in Q2 and $5.2m for the half.
- Adjusted EBITDA, a non-GAAP measure, was $20.9m in Q2 versus $14.0m and $40.7m for the half versus $27.7m. GAAP net income and cash flow provide different measures of performance; management cautions that adjusted EBITDA is not free cash flow.
Liquidity, debt and cash flow
- At June 30, cash and cash equivalents were $66.3m, down from $170.6m at year-end 2013; restricted cash was $9.1m. Total assets were $1.47bn, total liabilities $1.07bn and stockholders’ equity $391.1m.
- Warehouse notes payable were $719.9m and the term note carrying amount was $172.5m. The term loan’s reported outstanding principal was $174.1m; it bears LIBOR plus a 4.50% margin and matures in 2020. The company reported compliance with its debt covenants.
- For the first half, operating cash flow was negative $355.0m, investing cash flow negative $59.4m and financing cash flow positive $310.1m. Management attributed the operating cash outflow mainly to the timing and net funding of loans held for sale; excluding loan purchases and sales, operating cash flow was $17.1m.
- Warehouse facilities totaled $1.87bn in stated capacity, including a $400m uncommitted Fannie Mae line. Fannie Mae reduced that line from $500m in March. Management said it did not expect the reduction to significantly affect operations or results.
- Operational liquidity at the lending subsidiary was $137.3m against a stated minimum requirement of $17.7m. The company expected to fund another $36.5m of restricted liquidity over 48 months for DUS obligations, assuming no further portfolio changes.
Management outlook, risks and unusual items
- Management described improving property fundamentals but intense competition amid low 2014 loan maturities and ample capital from banks, life insurers and CMBS lenders. It did not provide numeric earnings guidance.
- Management expected continued growth in transitional lending during 2014, while noting competition from banks and life insurers. GSE originations were down 11% year over year through June 30; management expected continued competition for new loans and warned that lower GSE volumes could disproportionately reduce non-cash servicing-rights revenue. HUD originations were down 26% year to date.
- Servicing rights were carried at $349.2m; their estimated fair value was $432.0m. A 100-basis-point increase in the discount rate would reduce estimated fair value by $13.8m, highlighting valuation sensitivity.
- Fannie Mae DUS risk-sharing exposure had a stated maximum contingent amount of $3.7bn, which the filing says is not representative of expected loss. The risk-sharing allowance was $4.8m; no at-risk loans were 60 days delinquent at quarter-end, compared with $9.1m delinquent a year earlier.
- Two disclosed lawsuits remained unresolved. Capital Funding’s $1.8m judgment against Credit Suisse and affiliates was on appeal; the company cited indemnification arrangements and recorded no loss contingency. CA Funds Group sought $5.1m plus interest and costs over an alleged placement fee; the motion to dismiss was denied, discovery was ongoing, and no loss reserve was recorded.
- The company repurchased 2.45m shares from a large stockholder for $35.5m at $14.50 per share and retired them. Total first-half cash used to repurchase stock was $37.3m. Management did not expect to pay dividends in the foreseeable future.
- ASU 2014-09 on revenue recognition was effective for the company beginning January 1, 2017. Management was evaluating its impact and transition method.
Important facts for investors to verify
- Whether originations, mortgage-banking gains and margins stabilize as GSE and other lender competition evolves.
- How much interim lending grows, and the associated loan performance, funding needs and risk exposure.
- Warehouse-line renewal and availability, including the uncommitted Fannie Mae facility, and continued covenant compliance.
- MSR valuation assumptions and sensitivity, DUS risk-sharing reserves, and any changes in delinquencies or realized losses.
- Developments in both lawsuits, including the appeal and the effectiveness and scope of the stated indemnification arrangements.
- Cash generation after adjusting for the timing of loan funding and sales, rather than relying on reported operating cash flow alone.