Walker & Dunlop, Inc. — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011. Walker & Dunlop provides commercial real estate financing services, primarily multifamily lending, and generally originates, sells and services loans for Fannie Mae, Freddie Mac, HUD and other investors. Unless noted, amounts are in U.S. dollars.
Financial performance
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Total revenue | $42.4 million | $30.7 million | $71.4 million | $63.6 million |
| Income from operations | $18.2 million | $11.7 million | $29.1 million | $22.5 million |
| Net income, reported | $11.1 million | $11.7 million | $17.8 million | $22.5 million |
| Diluted earnings per share | $0.51 | $0.80 | $0.82 | $1.52 |
| Operating margin | 43% | 38% | 41% | 35% |
- Q2 revenue rose 38% and operating income rose 55%; first-half revenue rose 12% and operating income rose 29%. Origination volume increased 95% in Q2 to $1.31 billion and 10% for the half to $1.82 billion.
- Mortgage banking gains were $31.3 million in Q2 (+48%) and $48.1 million for the half (+4%). Servicing fees increased 23% in both periods. The servicing portfolio grew 13% year over year to $15.4 billion; average servicing fee rate rose to 0.22% from 0.19%.
- Q2 personnel expense increased 60% to $12.9 million, mainly from commissions on higher originations. First-half personnel expense fell 6% to $22.1 million. Amortization and depreciation increased 8% in Q2 and 22% for the half, reflecting a larger MSR portfolio. Operating margins improved as expenses grew more slowly than revenue overall.
- Reported net income comparisons are affected by the 2010 predecessor entities’ pass-through tax status and the company’s post-IPO corporate taxes. 2011 tax expense was $7.1 million in Q2 and $11.3 million for the half. On the filing’s pro forma, tax-adjusted basis, 2010 net income was $7.2 million for Q2 and $13.7 million for the half; against these figures, 2011 net income was up 55% and 29%, respectively.
Cash flow, debt and liquidity
- Cash and cash equivalents were $38.2 million at June 30, 2011, versus $33.3 million at December 31, 2010. Total assets were $680.8 million; stockholders’ equity was $145.5 million.
- Operating cash flow was negative $158.1 million for the first half, compared with positive $16.2 million in 2010. The company attributed the swing primarily to $156.1 million of net cash used to fund loan originations after loan-sale proceeds; loans are generally held briefly before sale. Excluding loan purchases and sales, operating cash flow was negative $2.0 million, versus positive $7.6 million.
- Financing cash flow was positive $163.6 million, principally due to $163.5 million of net warehouse borrowings. Investing cash flow was negative $0.6 million. Cash increased $4.9 million over the period.
- Warehouse notes payable were $412.0 million and other notes payable were $25.7 million at June 30. The term note balance was $25.2 million, with annual principal reductions of $3.6 million; its maturity was extended to October 2015. Warehouse and term debt generally bears interest at a spread over 30-day LIBOR.
- Management reported $37.8 million of operational liquidity against stated requirements of at least $8.7 million, and said it was in compliance with debt covenants. The filing states that cash flows from operations are expected to meet current obligations over the next 12 months. The company did not anticipate paying dividends in the foreseeable future.
Changes, outlook and risks
- Revenue and operating income improved on higher originations and servicing revenue, though loan origination fees as a share of volume declined. Q2 net warehouse interest income fell 34%, and first-half net warehouse interest income fell 18%, compared with 2010.
- Management described gradual economic growth and improving credit quality, including lower delinquency rates, and expected demand for commercial real estate loans to benefit from maturing debt and renewed investment activity. It expected GSEs and HUD to remain important to multifamily lending. No quantified earnings or revenue guidance was provided; management cautioned that results fluctuate with rates, transaction volumes and economic conditions.
- On July 21, 2011, after quarter-end, the company announced an interim loan program for experienced borrowers, with loan terms up to two years, funded through company capital and credit facilities. These loans are intended to be held for investment.
- Fannie Mae DUS loans create risk-sharing exposure. The risk-sharing allowance was $13.4 million, up from $10.9 million at year-end; 60-day delinquencies were 0.14% of the at-risk portfolio, down from 1.64% a year earlier. The maximum quantifiable contingent liability under DUS guarantees was $1.4 billion, which the company said was not representative of expected loss. Fannie Mae collateral changes were expected to require approximately $11 million of additional collateral over three years, subject to reassessment.
- MSRs had a reported fair value of $142.2 million. A 100-basis-point increase in the discount rate would reduce fair value by approximately $4.1 million. Rate sensitivity also includes an estimated $4.1 million annual reduction in net warehouse interest income for a 100-basis-point LIBOR increase, partly offset by higher escrow earnings and lower sensitivity from corporate debt.
- Capital Funding litigation was dismissed without prejudice on July 19, 2011, with an opportunity for the plaintiff to amend; the company cited indemnification arrangements and stated there was then no loss exposure. In the Drumm Investors matter, the borrower sought return of $4.2 million in advances and the company counterclaimed for $4.4 million in break-up fees; an asset-attachment motion was pending. Management said it did not expect pending litigation to have a material adverse effect, but outcomes are uncertain.
- Other risks include continued access to warehouse funding, covenant and collateral requirements, changing GSE and HUD policies, potential regulation under Dodd-Frank, credit losses under DUS guarantees, interest-rate and MSR valuation changes, and litigation. The company said there were no material changes to the risk factors in its 2010 Form 10-K.
Important facts for investors to verify
- How much of the sharp improvement in Q2 originations and mortgage banking revenue is repeatable, given lower fees per dollar of volume and changing product mix?
- Whether operating cash flow excluding loan purchases and sales improves, and whether warehouse facilities remain adequate and renewable as loan volumes and borrowings change.
- How DUS delinquency trends, allowance adequacy, collateral needs and potential servicing advances develop, particularly as Fannie Mae reassesses collateral requirements.
- Whether the interim loan program’s funding, credit performance and investment returns differ materially from the company’s established originate-and-sell model.
- The outcomes of the Drumm litigation and any amended Capital Funding complaint, as well as the extent to which indemnification protections are collectible.