Business context and reporting period
Walker & Dunlop, Inc. filed this unaudited Form 10-Q for the quarter ended September 30, 2019. The company originates, sells and services commercial real estate loans, brokers debt and multifamily property sales, and manages real estate investments. Comparisons below are with the three and nine months ended September 30, 2018, unless otherwise noted. Dollar amounts are in millions except per-share data.
Financial performance and position
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Total revenue | $212.3 | $184.7 | $600.0 | $510.3 |
| Income from operations | $59.3 | $50.7 | $172.4 | $147.5 |
| Walker & Dunlop net income | $44.0 | $37.7 | $130.5 | $115.7 |
| Diluted EPS | $1.39 | $1.15 | $4.11 | $3.56 |
| Adjusted EBITDA (non-GAAP) | $54.5 | $58.3 | $183.8 | $160.4 |
| Operating margin | 28% | 27% | 29% | 29% |
- Q3 revenue rose 15%, operating income 17%, net income 17% and diluted EPS 21%. For the nine months, revenue rose 18%, operating income 17%, net income 13% and diluted EPS 15%. Q3 adjusted EBITDA fell about 6%; nine-month adjusted EBITDA increased 15%.
- Revenue growth reflected mortgage banking gains, servicing fees, warehouse interest income, escrow earnings and property sales brokerage. Q3 mortgage banking gains increased 17% to $115.9 million; property sales broker fees increased 62% to $9.6 million. For the nine months, mortgage banking gains increased 14% to $321.5 million.
- Expense growth absorbed part of the revenue increase: Q3 personnel expense rose 17% and other operating expense 33%; nine-month personnel expense rose 21% and other operating expense 21%. Management attributed increases principally to hiring, commissions, bonuses, recruiting and occupancy costs.
- At September 30, 2019, total assets were $2.981 billion, total liabilities $1.979 billion and total equity $1.002 billion. Cash and cash equivalents were $65.6 million; restricted cash was $9.1 million and pledged securities were $120.3 million.
- Warehouse notes payable were $1.263 billion and the note payable was $294.3 million on the balance sheet; the term loan’s unpaid principal was $297.8 million. Total cash, cash equivalents and restricted cash in the cash-flow presentation were $80.1 million.
- Cash used in operating activities was $93.0 million for the nine months, compared with $1.097 billion used in 2018. The company said loan origination and sale activity used $188.2 million net, while operating cash flow excluding that activity was positive $95.1 million. Investing activities provided $16.8 million and financing activities provided $36.0 million. Total cash, cash equivalents and restricted cash decreased $40.2 million.
- The servicing portfolio grew to $91.8 billion from $85.7 billion at December 31, 2018. Mortgage servicing rights had a $697.4 million carrying value and $884.4 million estimated fair value. A 100-basis-point increase in the MSR discount rate would reduce estimated fair value by $27.5 million, a hypothetical sensitivity disclosed by the company.
Material changes and management commentary
- Total mortgage banking volume increased 8% in Q3 and 10% for the nine months. Property sales volume increased to $1.616 billion for Q3 from $882.1 million and to $3.414 billion for the nine months from $1.703 billion.
- Q3 gains from mortgage banking benefited from higher volume and a higher MSR rate, particularly on Fannie Mae business. Nine-month servicing fees increased with portfolio growth, though average servicing fee rates declined 7% year over year in both periods.
- Net warehouse interest income increased to $6.2 million for Q3 and $19.6 million for the nine months, driven by loans held for investment. Management cautioned that tighter spreads on loans held for sale could persist if the yield curve remains flat or inverts, and that a large corporate-cash-funded loan was scheduled to mature in Q4 2019.
- Interim loan originations were $304.8 million for the nine months, down from $402.7 million. The company reported growth in brokered activity and added 16 property sales brokers during Q3.
- Management described multifamily property fundamentals as strong and expected continued financing-market strength, while noting intense competition. It cited projected MBA commercial and multifamily mortgage originations of $359 billion in 2019 and $390 billion in 2020. These are market expectations, not company financial guidance.
Outlook, risks and unusual items
- The filing provides no specific company revenue or earnings guidance. Management expected its effective tax rate for the remainder of 2019 to be approximately 26%–27% and said it expected to continue regular quarterly dividends. The board declared a $0.30-per-share Q4 2019 dividend.
- Key exposures include dependence on Fannie Mae and Freddie Mac: most originations and a substantial majority of servicing rights are tied to GSE programs. Changes to the GSEs, their conservatorship, FHFA rules or lending caps could materially affect the business. FHFA set caps of $100 billion per GSE for the five-quarter period from Q4 2019 through Q4 2020, applying to all multifamily business.
- Fannie Mae DUS risk-sharing maximum quantifiable contingent liability was $7.4 billion; the filing cautions this is not an estimate of likely loss. The related allowance was $7.3 million. Additional pledged liquidity of $66.9 million was expected to be funded over 48 months, assuming no further portfolio paydowns, prepayments or defaults.
- One $14.7 million unpaid-principal-balance loan held for investment was delinquent, impaired and on non-accrual after a maturity default. The company had agreed on a recapitalization, new property management and loan extension, with restructuring expected in Q4 2019; it anticipated an immaterial loss of unpaid interest.
- The expected-credit-loss standard (ASU 2016-13) was scheduled for adoption January 1, 2020. The company expected its allowance for risk-sharing obligations to increase substantially, while the ultimate financial-statement impact was still being finalized.
- Interest-rate sensitivity disclosures estimate that a 100-basis-point LIBOR increase would reduce annual escrow earnings by $24.7 million, reduce annual net warehouse interest income by $9.7 million, and reduce annual income from operations by $3.0 million, based on period-end balances and stated assumptions. Warehouse and term-loan covenants were met at quarter-end.
- The company reported ordinary-course litigation it considered immaterial, no material subsequent events requiring recognition, and effective disclosure controls. It also disclosed an immaterial prior-period EPS calculation correction and adoption of the lease standard, which reduced opening retained earnings by $1.0 million.
Important facts for investors to verify
- Whether mortgage banking volumes, servicing growth and property sales activity can be sustained, and how GSE caps and policy changes affect origination economics.
- How the expected substantial increase in risk-sharing reserves under the 2020 credit-loss standard affects earnings, equity and capital requirements.
- Progress and ultimate recovery on the delinquent $14.7 million held-for-investment loan, and any change in DUS defaults or reserves.
- Cash conversion and liquidity needs given negative reported operating cash flow, required additional DUS collateral and reliance on warehouse facilities, including their maturities and renewal terms.
- Whether personnel and operating-cost growth remains proportionate to revenue, particularly given the decline in Q3 adjusted EBITDA despite higher GAAP net income.
- MSR valuation assumptions, prepayment behavior and sensitivity to discount rates, as well as the ongoing decline in servicing fee rates.