Walker & Dunlop, Inc. annual report, FY2015

Walker & Dunlop, Inc. — 2015 Form 10-K

Reporting period: Fiscal year ended December 31, 2015; comparisons are primarily with fiscal 2014. Walker & Dunlop is a commercial real estate finance company focused on multifamily lending, loan servicing and, since 2015, investment-sales brokerage.

Financial performance and position

Metric	2015	2014	Change
Total revenue	$468.2 million	$360.8 million	+30%
Operating income	$135.4 million	$83.9 million	+61%
Walker & Dunlop net income	$82.1 million	$51.4 million	+60%
Diluted EPS	$2.65	$1.58	+68%
Operating margin	29%	23%	+6 percentage points
Adjusted EBITDA (non-GAAP)	$124.3 million	$84.8 million	+47%

• Mortgage-banking gains increased 31% to $290.5 million, primarily reflecting higher loan volume. Servicing fees rose 17% to $114.8 million as the average servicing portfolio grew. “Other” revenue increased 88% to $34.5 million, including investment-sales and prepayment-fee income.
• Total loan originations rose 43% to $16.24 billion. Fannie Mae volume was $5.01 billion; Freddie Mac, $6.33 billion; HUD/Ginnie Mae, $592 million; brokered loans, $3.94 billion; and interim loans, $185 million. The servicing portfolio reached $50.21 billion, up 14%.
• Expenses increased 20% to $332.8 million. Personnel expense rose 24% to $184.6 million, driven by commissions, bonuses, headcount and share-based compensation. Amortization and depreciation rose 21% to $96.2 million, reflecting MSR amortization and write-offs.
• Year-end cash and cash equivalents were $137.0 million; total assets, $3.515 billion; total liabilities, $3.023 billion; and total equity, $492.3 million. Loans held for sale were $2.499 billion and MSRs were $412.3 million.
• Warehouse notes payable were $2.649 billion, largely funding loans held for sale and investment. The term loan’s carrying amount was $164.5 million (principal outstanding $168.4 million). The company reported compliance with warehouse covenants and substantial headroom against agency liquidity and net-worth requirements.
• Operating cash flow was negative $1.340 billion, primarily reflecting $1.423 billion of net cash used in loan-origination activity as originations outpaced loan sales at the reporting date. Excluding loan-origination activity, operating cash flow was positive $83.6 million, versus $47.0 million in 2014. Financing cash flow was positive $1.386 billion, primarily due to warehouse borrowings. Ending cash increased $23.6 million.

Material changes and developments

• Origination growth was led by Freddie Mac and brokered lending; HUD originations declined 16% to $592 million. Correspondents generated 15% of originations, down from 22% in 2014.
• The company acquired a 75% interest in Engler Financial Group’s investment-sales business in April 2015. The business closed $1.5 billion of transactions during its first eight months; 2015 investment-sales volume was $1.52 billion.
• Walker & Dunlop increased its CMBS Partnership interest from 20% to 40% in 2015. Effective January 1, 2016, it acquired the remaining interest and began consolidating the partnership. The partnership originated $309.5 million in 2015 and contributed $279.8 million of loans to three securitizations.
• The company repurchased approximately 3.0 million shares during the first quarter of 2015 for $46.8 million, and total 2015 repurchases were $50.3 million. Shares outstanding at year-end were 29.5 million, versus 31.8 million a year earlier. The board authorized up to $75 million of additional repurchases over 12 months in early 2016.
• MSR carrying value rose to $412.3 million from $375.9 million. Management estimates fair value using discounted cash flows; a 100-basis-point increase in the discount rate would reduce estimated MSR fair value by approximately $16 million.

Outlook, risks and contingencies

• No specific numerical earnings or revenue guidance is provided. Management described its capital-markets outlook as positive, citing expected loan maturities and refinancing demand, and said it did not anticipate a significant decline in originations or profitability from the Federal Reserve’s December 2015 rate increase. It cautioned that further rate increases and macroeconomic conditions could change the outlook.
• Management cited strong multifamily fundamentals and expected the broader commercial and multifamily market to exceed $225 billion in 2016. GSE multifamily purchase caps were set at $31 billion each for 2016, subject to exclusions and possible adjustment. The company warned that future GSE reform, purchase limits or changes to agency relationships could materially affect revenue and servicing growth.
• CMBS market spreads widened and demand weakened in late 2015 and early 2016, potentially affecting securitization volumes. Interim lending carries full credit risk; the company held 13 interim loans totaling $233.4 million at year-end and reported no delinquencies or charge-offs in that program.
• Fannie Mae risk-sharing exposure covered a $19.54 billion at-risk portfolio. The allowance was $5.6 million and the guaranty obligation was $27.6 million; no at-risk loans were 60 or more days delinquent at year-end. The company had pledged $70.9 million of securities as collateral and expected to fund a further $46.4 million of restricted liquidity over 48 months, assuming no portfolio reductions or defaults.
• Committed agency warehouse facilities included temporary increases that were scheduled to expire in February 2016, while several facilities matured during 2016 and were subject to renewal. The company identified continued access to warehouse funding as essential; nonrenewal or covenant breaches could constrain originations and liquidity.
• The company committed to $42.8 million of preferred-equity investments, none funded at December 31, 2015, with funding expected over 18–36 months beginning in 2016. These investments are subordinate to debt and are not secured by real estate.
• The Capital Funding litigation concluded after the appellate court affirmed the judgment; Credit Suisse paid the judgment. In a separate CA Funds Group matter seeking $5.1 million plus interest and costs, the company won summary judgment in January 2016; CAFG filed an appeal in February. Management said it did not consider pending litigation liabilities likely to have a material adverse effect.

Important facts for investors to verify

• Whether strong originations and servicing growth continue, and how agency caps, GSE reform and competition affect loan pricing and MSR economics.
• Whether temporary warehouse capacity is renewed or replaced on acceptable terms, and whether the company maintains covenant compliance as funding needs grow.
• The sensitivity of reported earnings and equity to MSR assumptions, prepayments, credit losses, and the increase in MSR amortization and write-offs.
• The performance, funding and consolidation effects of the CMBS business after the January 2016 acquisition of full ownership, particularly amid securitization-market volatility.
• The funding and risk terms of the $42.8 million preferred-equity commitments, and the outcome of CAFG’s appeal and any related fee recovery.
• Adjusted EBITDA is a non-GAAP measure and excludes items including MSR-related non-cash gains; compare it with GAAP net income and cash flow rather than treating it as free cash flow.