Walker & Dunlop, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018; balance-sheet comparisons are to December 31, 2017. The company originates, sells and services commercial real estate loans, primarily multifamily, and also provides brokerage and investment-management services. Dollar figures below are in millions unless otherwise noted.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenue | $184.7 | $179.7 | $510.3 | $504.7 |
| Operating income | $50.7 | $54.7 | $147.5 | $166.9 |
| Walker & Dunlop net income | $37.7 | $34.4 | $115.7 | $112.2 |
| Diluted EPS | $1.17 | $1.06 | $3.60 | $3.49 |
| Operating margin | 27% | 30% | 29% | 33% |
| Adjusted EBITDA (non-GAAP) | $58.3 | $45.0 | $160.4 | $146.3 |
Q3 revenue increased 3%, while operating income fell 7%; net income rose 10%, helped by lower tax expense. For the first nine months, revenue rose 1%, operating income fell 12%, and net income increased 3%. Adjusted EBITDA rose 30% in Q3 and 10% year to date; it excludes, among other items, noncash gains attributable to MSRs and should not be treated as a substitute for GAAP earnings or cash flow.
Revenue mix showed contrasting trends: mortgage-banking gains declined 11% in Q3 and 9% year to date, while servicing fees rose 13% and 14%, respectively. Net warehouse interest income fell 28% in Q3 and 54% year to date. Escrow and other interest income more than doubled year to date, benefiting from higher rates and larger escrow balances. Expenses rose 7% in both periods, with higher personnel, amortization/depreciation and other operating costs.
Balance sheet, cash flow and liquidity
- At September 30, total assets were $3.57 billion, total liabilities $2.66 billion, and total equity $906.4 million. Loans held for sale were $2.13 billion, up from $951.8 million at year-end; warehouse notes payable were $2.16 billion, up from $937.8 million.
- Cash and cash equivalents were $165.1 million; restricted cash was $16.2 million. Cash, cash equivalents and restricted cash plus pledged cash equivalents totaled $221.6 million, versus $286.7 million at December 31, 2017.
- For the nine months, operating cash flow was negative $1.10 billion, primarily reflecting the timing and funding of loan originations and sales. Investing cash flow was negative $206.0 million and financing cash flow positive $1.24 billion, including $1.23 billion of net warehouse borrowings. Excluding loan-origination activity, operating cash flow was positive $93.1 million.
- Warehouse facilities had aggregate capacity of $4.78 billion, including uncommitted capacity, with $2.16 billion outstanding. The separate term note had $163.6 million carrying value ($165.4 million principal outstanding) and matures in December 2020. The company reported covenant compliance at quarter-end.
- Operational liquidity at the operating subsidiary was $170.0 million against a stated minimum requirement of $33.1 million. Fannie Mae-defined net worth was $724.1 million versus a $168.1 million requirement.
- The servicing portfolio was $80.6 billion, compared with $74.3 billion at year-end. Net carrying value of mortgage servicing rights (MSRs) was $647.2 million; estimated fair value was $857.0 million.
Material changes and operating developments
- Total loan origination volume declined 11% in Q3 to $6.77 billion and 6% year to date to $16.99 billion. Q3 Freddie Mac volume fell materially, while brokered originations rose 30% and interim originations increased to $185.8 million from $26.4 million. Year-to-date interim originations were $402.7 million versus $189.6 million.
- Management attributed lower mortgage-banking gains partly to reduced new-loan servicing fees amid competition and tighter credit spreads, and to lower origination volume. The nine-month comparison also reflects a large $1.9 billion GSE loan portfolio originated in Q3 2017 with no comparable 2018 transaction.
- The servicing portfolio expanded, supporting fee growth, but the average servicing fee rate declined. A flatter yield curve reduced the spread on loans held for sale; management noted that further short-rate increases could continue to pressure warehouse spreads.
- The company acquired JCR Capital in Q2 2018 to expand investment management. JCR reported $837.8 million of assets under management at September 30; its operating results were described as immaterial for the reported periods. A separate $20 million Southeast mortgage-banking acquisition was expected to close in Q4 and was not expected to have a material financial impact.
- The company began quarterly cash dividends in 2018, declaring $0.25 per share for each quarter; $23.6 million was paid in the first nine months. It repurchased $26.7 million of stock in that period and had $45.9 million remaining under its $50 million repurchase authorization at quarter-end.
Outlook, risks and unusual items
Management characterized multifamily fundamentals as strong, citing rental demand, low vacancy and delinquency, and continued loan-market activity. It expected continued multifamily market strength and regular quarterly dividends for the foreseeable future, but provided no formal revenue or earnings guidance. Management said it expected the 2018 annual effective tax rate to remain near 26.2%; the reported nine-month effective rate was 21.7%, reflecting timing and tax benefits.
- GSE and market exposure: Fannie Mae and Freddie Mac are important sources of business; future FHFA policy, GSE production limits and market share could affect originations. 2018 market-rate caps were $35 billion each for Fannie Mae and Freddie Mac. Management noted uncertainty about any tighter limits after 2018.
- Credit guarantees: Under Fannie Mae DUS, the maximum quantifiable contingent liability was $6.4 billion, which the filing says is not representative of expected loss. The allowance for risk-sharing obligations was $4.7 million; 60-plus-day delinquencies in the at-risk portfolio were $11.1 million, or 0.04%. Fannie Mae increased the company’s full risk-sharing cap from $60 million to $200 million in Q2; maximum exposure on any one loan can be $40 million under the stated assumptions.
- Collateral and liquidity demands: The company expected to fund another $65.2 million of DUS pledged collateral over the next 48 months, assuming no portfolio changes. Changes in Fannie Mae collateral standards could constrain available cash. A $500 million Agency warehouse line expired in Q3; management said remaining facilities were sufficient for current operations.
- Interest-rate and valuation sensitivity: A 100-basis-point rise in the MSR discount rate would reduce estimated MSR fair value by $26.7 million. A 100-basis-point rise in LIBOR was estimated to increase annual escrow earnings by $21.6 million, reduce annual net warehouse interest income by $10.5 million, and reduce annual operating earnings by $1.7 million on corporate debt, based on period-end balances. These are sensitivities, not forecasts.
- Other items: Hurricane Florence affected properties securing some risk-sharing loans; management reported no material impact based on its preliminary assessment. Tax-reform guidance could affect the deductibility of certain executive compensation; $2.6 million of related deferred tax assets was provisionally recorded pending final guidance. The company expected the new expected-credit-loss standard, planned for adoption in 2020, to increase its risk-sharing allowance, though the amount was not yet determined.
The filing reported no material change in risk factors from the 2017 Form 10-K, no material litigation, and effective disclosure controls. It noted that results may fluctuate with interest rates, transaction volume, acquisitions, regulation and economic conditions.
Important facts for investors to verify
- Whether servicing-fee growth can offset pressure on mortgage-banking gains, origination volume and warehouse spreads.
- How much of reported earnings depends on noncash MSR recognition, and whether MSR valuation assumptions and prepayment experience change.
- Warehouse-line availability, maturity renewals, utilization and covenant compliance, particularly given the increase in loan-held-for-sale balances and reliance on uncommitted capacity.
- Actual and potential losses under DUS risk sharing, including the effects of the higher risk-sharing cap and future collateral requirements.
- The eventual tax accounting for executive compensation and the quantified effect of adopting the expected-credit-loss standard.
- JCR’s contribution to revenue, earnings and assets under management, and the status and economics of acquisitions or preferred-equity investments made after quarter-end.