Walker & Dunlop, Inc. annual report, FY2014

Walker & Dunlop, Inc. — 2014 Form 10-K

Reporting period: Fiscal year ended December 31, 2014. The filing also provides unaudited fourth-quarter results. Walker & Dunlop is a commercial real estate finance company focused primarily on multifamily lending, originating, selling and servicing loans through Fannie Mae, Freddie Mac, HUD/Ginnie Mae, institutional investors and proprietary lending programs.

Financial performance and key metrics

Metric	FY 2014	FY 2013	Change
Total revenue	$360.8 million	$319.0 million	+13%
Income from operations	$83.9 million	$66.8 million	+26%
Net income	$51.4 million	$41.5 million	+24%
Diluted EPS	$1.58	$1.21	+31%
Operating margin	23%	21%	+2 percentage points
Total originations	$11.37 billion	$8.40 billion	+35%
Servicing portfolio, year-end	$44.03 billion	$38.94 billion	+13%

• Revenue growth reflected higher mortgage banking gains ($222.0 million, +9%), servicing fees ($98.4 million, +9%) and net warehouse interest income. Servicing fees benefited from portfolio expansion.
• Profit growth outpaced revenue growth; expenses rose 10% to $276.9 million. Personnel expense increased 12% to $149.4 million, mainly from commissions and bonuses. Corporate-debt interest expense increased to $10.3 million from $3.7 million.
• Mortgage banking gains include estimated, largely non-cash servicing-rights value. Gains attributable to MSRs were $103.4 million at loan commitment, before $6.9 million of associated guaranty obligations. Investors should distinguish these estimates from cash generation.
• Management-reported adjusted EBITDA, a non-GAAP measure, was $84.8 million versus $56.8 million. Adjusted diluted EPS was $1.59 versus $1.28; the filing cautions these measures are not substitutes for GAAP results.
• Fourth-quarter 2014 revenue was $112.6 million, net income $16.3 million and diluted EPS $0.50, compared with $85.5 million, $11.2 million and $0.33, respectively, in fourth-quarter 2013. Quarterly figures are unaudited.

Cash flow, balance sheet and liquidity

• Cash and cash equivalents were $113.4 million at year-end, down from $170.6 million. Total assets were $2.014 billion, liabilities $1.581 billion and equity $433.5 million.
• Operating cash flow was a use of $729.5 million, versus $836.9 million provided in 2013. This swing was principally driven by the timing and volume of loans originated and sold: the company used $776.5 million net to fund loan originations in 2014, compared with a $797.7 million net cash inflow in 2013. Excluding loan purchases and sales, operating cash flow was positive $47.0 million.
• Investing activities used $115.6 million; financing activities provided $787.9 million, primarily reflecting higher warehouse borrowing. The company also used $35.5 million to repurchase shares from a large stockholder and $17.6 million cash for the Johnson Capital acquisition.
• Warehouse notes payable were $1.216 billion and term-note carrying value was $171.8 million. Warehouse debt primarily funds loans held for sale or investment and is generally repaid from loan sales or payoffs; it should be considered alongside the related loan assets. The $175 million term loan carries variable-rate interest, currently LIBOR plus 4.25%, and matures in December 2020.
• Management reported $1.9 billion of committed warehouse funding and $475 million of uncommitted Fannie Mae funding capacity. Several facilities require renewal, and the uncommitted facility is not assured funding. The company said it complied with all warehouse covenants at year-end.
• Agency liquidity tests were met: operational liquidity was $125.3 million against a $19.0 million minimum; net worth was $326.0 million against a $98.6 million requirement. Fannie Mae collateral pledged was $67.7 million, and management estimated another $36.5 million would need to be funded over the following 48 months, assuming no portfolio changes.

Material changes and business developments

• Origination volume increased to $11.37 billion. Fannie Mae originations rose 45% to $4.00 billion and Freddie Mac originations rose to $3.63 billion from $1.71 billion. HUD/Ginnie Mae volume declined 38% to $704.5 million; brokered originations were nearly flat at $2.61 billion.
• The company acquired certain Johnson Capital assets and liabilities on November 1, 2014 for $23.5 million, including $17.6 million cash and $5.9 million in stock. The acquisition added origination capacity and $0.6 billion to servicing. It also launched a proprietary CMBS platform through a partnership; that partnership originated $116.1 million during 2014.
• Balance-sheet interim originations were $339.8 million, up from $192.0 million; year-end interim loans held for investment totaled $225.3 million across 12 loans. The company bears the full credit risk on these loans and reported no delinquencies or charge-offs in the program.
• The company repurchased 2.5 million shares from a large stockholder in March 2014 for approximately $35.5 million, at $14.50 per share. It did not pay cash dividends and said it retains earnings to fund growth.

Outlook, commentary and principal risks

• Management described improving multifamily fundamentals, but intense lending competition pressured origination and MSR rates. It expected the GSEs to remain active in 2015, anticipated opportunities from the 2015–2017 commercial mortgage maturity wave, and expected interim lending to remain active. These are qualitative expectations, not quantified company earnings guidance.
• For 2015, FHFA set a $30 billion multifamily origination cap for each GSE, with specified affordable-housing, small-property and manufactured-housing loans excluded. The filing notes uncertainty about future GSE policy and housing-finance reform. GSE and HUD relationships are central to origination and servicing revenues.
• Credit exposure includes Fannie Mae DUS risk-sharing on a $17.4 billion at-risk portfolio. The allowance was $3.9 million; 60+-day delinquencies were $16.6 million, or 0.10% of the at-risk balance, up from 0.02%. Maximum contractual risk exposure was stated as $4.1 billion, a severe-case amount rather than expected loss. Interim loans carry 100% company risk.
• Other key risks include warehouse-facility renewal and covenant/cross-default exposure, required servicing advances, interest-rate and MSR valuation sensitivity, competitive pricing, regulatory changes and possible increases in Fannie Mae collateral requirements. A 100-basis-point rise in LIBOR was estimated to reduce annual net warehouse interest income by $6.3 million, partly offset by a $10.9 million increase in escrow earnings, and reduce annual earnings by about $0.3 million from corporate debt. A 100-basis-point increase in the MSR discount rate would reduce estimated MSR fair value by $15.4 million.
• Pending matters include a Capital Funding appeal involving a $1.8 million judgment, which the company says is covered by indemnification subject to a $3.0 million exposure cap, and a CA Funds Group claim seeking $5.1 million plus interest and costs. The company intends to defend the latter and reported that it had not recorded a loss reserve. Outcomes remain uncertain.
• The company reported effective disclosure controls and internal control over financial reporting; the independent auditor issued unqualified opinions on the financial statements and internal controls.

Investor verification priorities

• Reconcile reported earnings and adjusted measures with cash flow, especially the non-cash MSR contribution and volatile cash effects from loan originations and sales.
• Review the 2015 status, capacity, maturities and renewal terms of committed and uncommitted warehouse facilities, as well as covenant headroom and cross-default provisions.
• Track Fannie Mae DUS delinquencies, reserve adequacy, collateral funding needs and any changes to GSE program caps or risk-sharing terms.
• Assess interim-loan performance and concentration as the company expands balance-sheet lending, and monitor the new CMBS partnership’s economics and related-party governance.
• Follow the pending litigation, Johnson Capital integration, and whether management’s qualitative 2015 growth expectations materialize.