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WD > SEC Filings for WD > Form 10-Q on 8-Nov-2012All Recent SEC Filings

Show all filings for WALKER & DUNLOP, INC.

Form 10-Q for WALKER & DUNLOP, INC.


Quarterly Report

Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations

The following discussion should be read in conjunction with the historical financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q. The following discussion contains, in addition to historical information, forward-looking statements that include risks and uncertainties. Our actual results may differ materially from those expressed or contemplated in those forward looking statements as a result of certain factors, including those set forth under the headings "Forward-Looking Statements" and "Risk Factors" elsewhere in this Quarterly Report on Form 10-Q.

Forward-Looking Statements

Some of the statements in this quarterly report on Form 10-Q of Walker & Dunlop, Inc. and subsidiaries (the "Company," "Walker & Dunlop," "we," "us"), may constitute forward-looking statements within the meaning of the federal securities laws. Forward-looking statements relate to expectations, projections, plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts. In some cases, you can identify forward-looking statements by the use of forward-looking terminology such as "may," "will," "should," "expects," "intends," "plans," "anticipates," "believes," "estimates," "predicts," or "potential" or the negative of these words and phrases or similar words or phrases which are predictions of or indicate future events or trends and which do not relate solely to historical matters. You can also identify forward-looking statements by discussions of strategy, plans or intentions.

The forward-looking statements contained in this Form 10-Q reflect our current views about future events and are subject to numerous known and unknown risks, uncertainties, assumptions and changes in circumstances that may cause actual results to differ significantly from those expressed or contemplated in any forward-looking statement. Statements regarding the following subjects, among others, may be forward-looking:

† the future of Fannie Mae and the Federal Home Loan Mortgage Corporation ("Freddie Mac," and together with Fannie Mae, the government-sponsored enterprises, or the "GSEs") and their impact on our


†          our growth strategy;

†          our ability to integrate CWCapital's business with our own

†          our projected financial condition, liquidity and results of

†          our ability to obtain and maintain warehouse and other loan funding


† availability of and our ability to retain qualified personnel and our ability to develop relationships with borrowers, key principals and lenders;

†          degree and nature of our competition;

†          the outcome of pending litigation;

†          changes in governmental regulations and policies, tax laws and rates,
and similar matters and the impact of such regulations, policies and actions;

†          our ability to comply with the laws, rules and regulations applicable
to us;

†          trends in the commercial real estate finance market, interest rates,

commercial real estate values, the credit and capital markets or the general economy; and

† general volatility of the capital markets and the market price of our common stock.

While forward-looking statements reflect our good faith projections, assumptions and expectations, they are not guarantees of future results. Furthermore, we disclaim any obligation to publicly update or revise any forward-looking statement to reflect changes in underlying assumptions or factors, new information, data or methods, future events or other changes, except as required by applicable law. For a further discussion of these and other factors that could cause future results to differ materially from those expressed or contemplated in any forward-looking statements, see "Risk Factors."


We are one of the leading commercial real estate finance companies in the United States, with a primary focus on multifamily lending. We originate, sell and service a range of multifamily and other commercial real estate financing products. Our clients are owners and developers of commercial real estate across the country. We originate and sell loans through the programs of Fannie Mae, Freddie Mac, the Government National Mortgage Association ("Ginnie Mae") and the Federal Housing Administration, a division of the U.S. Department of Housing and Urban Development (together with Ginnie Mae, "HUD"), with which we have long-established relationships. We retain servicing rights and asset management responsibilities on nearly all loans that we originate for GSE and HUD programs. We are approved as a Fannie Mae Delegated Underwriting and Servicing ("DUS" ™) lender nationally, a Freddie Mac Program Plus™ lender in 22 states and the District of Columbia, a HUD Multifamily Accelerated Processing ("MAP") lender nationally, and a Ginnie Mae issuer. We also originate and service loans for a number of life insurance companies, commercial banks and other institutional investors, in which cases we do not fund the loan but rather act as a loan broker. Additionally, through our subsidiary entities, we provide institutional advisory, asset management and investment management services specializing in debt, structured debt and equity.

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We fund loans for GSE and HUD programs, generally through warehouse facility financings, and sell them to investors in accordance with the related loan sale commitment, which we obtain prior to loan closing. Proceeds from the sale of the loan are used to pay off the warehouse facility. The sale of the loan is typically completed within 60 days after the loan is closed. In cases where we do not fund the loan, we act as a loan broker and service some of the loans. Our originators who focus on loan brokerage are engaged by borrowers to work with a variety of institutional lenders to find the most appropriate loan instrument for the borrowers' needs. These loans are then funded directly by the institutional lender and we receive an origination fee for placing the loan and a servicing fee for any loans we service.

We recognize gains from mortgage banking activities when we commit to both make a loan to a borrower and sell that loan to an investor. The gains from mortgage banking activities reflect the fair value attributable to loan origination fees, premiums or losses on the sale of loans, net of any co-broker fees, and the fair value of the expected net future cash flows associated with the servicing of loans, net of any guaranty obligations retained. We also generate revenue from net warehouse interest income we earn while the loan is held for sale in one of our warehouse facilities.

We retain servicing rights on substantially all of the loans we originate and sell, and generate revenues from the fees we receive for servicing the loans, interest income from escrow deposits held on behalf of borrowers, late charges and other ancillary fees. Servicing fees are set at the time an investor agrees to purchase the loan and are generally paid monthly for the duration of the loan. Our Fannie Mae and Freddie Mac servicing engagements generally provide for prepayment penalties to the Company in the event of a voluntary prepayment. For loans serviced outside of Fannie Mae and Freddie Mac, we typically do not share in any such payments.

We are currently not exposed to interest rate risk during the loan commitment, closing and delivery process. The sale or placement of each loan to an investor is negotiated prior to establishing the coupon rate for the loan. We also seek to mitigate the risk of a loan not closing. We have agreements in place with the GSEs and HUD that specify the cost of a failed loan delivery, also known as a pair off fee, in the event we fail to deliver the loan to the investor. The pair off fee is typically less than the deposit we collect from the borrower. Any potential loss from a catastrophic change in the property condition while the loan is held for sale using warehouse facility financing is mitigated through property insurance equal to replacement cost. We are also protected contractually from any failure to close by an investor. We have experienced only one failed delivery in our history and did not incur any loss.

We have risk-sharing obligations on most loans we originate under the Fannie Mae DUS program. When a Fannie Mae DUS loan is subject to full risk-sharing, we absorb losses on the first 5% of the unpaid principal balance of a loan, and above 5% we share a percentage of the loss with Fannie Mae, with our maximum loss capped at 20% of the unpaid principal balance of a loan (subject to doubling or tripling if the loan does not meet specific underwriting criteria or if the loan defaults within 12 months of its sale to Fannie Mae). We may, however, request modified risk-sharing at the time of origination, which reduces our potential risk-sharing losses from the levels described above. We regularly request modified risk-sharing based on such factors as the size of the loan, market conditions and loan pricing. We may also request modified risk-sharing on large transactions if we do not believe that we are being fully compensated for the risks of the transactions or to manage overall risk levels. Except for certain Fannie Mae DUS loans acquired in the acquisition of certain assets of Column Guaranteed LLC, in 2009, which were acquired subject to their existing Fannie Mae DUS risk-sharing levels, our current credit management policy is to cap each loan balance subject to full risk-sharing at $60 million. Accordingly, we currently elect to use modified risk-sharing for loans of more than $60 million in order to limit our maximum loss exposure on any one loan to $12 million (such exposure would occur in the event that the underlying collateral is determined to be completely without value at the time of loss).

Our servicing fees for risk-sharing loans include compensation for the risk-sharing obligations and are larger than the servicing fees we receive from Fannie Mae for loans with no risk-sharing obligations. We receive a lower servicing fee for modified risk-sharing than for full risk-sharing.

We offer our borrowers an interim loan program offering floating-rate debt, for terms of up to two years, to experienced borrowers seeking to acquire or reposition multifamily properties that do not currently qualify for permanent financing. We closed our first loans under this program in 2012. We underwrite all loans originated through the program. During the time that they are outstanding, we assume the full risk of loss on the loans. In addition, we service and asset-manage loans originated through the program, with the ultimate goal of providing permanent financing on the properties.

On June 7, 2012, the Company entered into a purchase agreement (the "Purchase Agreement"), by and among the Company, its indirect wholly owned subsidiary, Walker & Dunlop, LLC, CWCapital LLC ("CWCapital") and CW Financial Services LLC ("CW Financial"), pursuant to which Walker & Dunlop, LLC agreed to acquire all of CW Financial's interests in CWCapital (the "Acquisition"), for approximately $220 million (comprising a cash payment to CW Financial of $80 million and the balance consisting of the Company's issuance in a private placement to CW Financial of approximately 11.6 million shares of common stock).

The Acquisition closed, pursuant to the terms of the Purchase Agreement, on September 4, 2012. Upon closing of the Acquisition, CWCapital became an indirect wholly owned subsidiary of the Company and was renamed Walker & Dunlop Captial,
LLC. The consideration transferred at the close of the Acquisition totaled approximately $231 million, consisting of $80 million in cash and 11,647,255 shares of the Company's common stock at a closing date fair value of $151 million.

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Basis of Presentation

The accompanying condensed consolidated financial statements include all of the accounts of the Company and its wholly owned subsidiaries and all material intercompany transactions have been eliminated.

Critical Accounting Policies

Our condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, which require management to make estimates and assumptions that affect reported amounts. The estimates and assumptions are based on historical experience and other factors management believes to be reasonable. Actual results may differ from those estimates and assumptions. We believe the following critical accounting policies represent the areas where more significant judgments and estimates are used in the preparation of our condensed consolidated financial statements.

Mortgage Servicing Rights and Guaranty Obligations. MSRs are recorded at fair value the day we sell a loan. We only recognize MSRs for GSE and HUD originations. Our servicing contracts with non-governmental originations are cancelable with limited notice and as a result, have a de minimis fair value. The fair value is based on the expected future net cash flows associated with the servicing rights. The expected net cash flows are discounted at a rate that reflects the credit and liquidity risk of the MSR over the estimated life of the underlying loan.

In addition to the MSR, for all Fannie Mae DUS loans with risk-sharing obligations, upon sale we record the fair value of the obligation to stand ready to perform over the term of the guaranty (non-contingent obligation), and the fair value of the expected loss from the risk-sharing obligations in the event of a borrower default (contingent obligation). In determining the fair value of the guaranty obligation, we consider the risk profile of the collateral, historical loss experience, and various market indicators. Generally, the estimated fair value of the guaranty obligation is based on the present value of the future cash flows expected to be paid under the guaranty over the life of the loan (historically three to five basis points annually), discounted using a 12-15 percent discount rate. Historically, the contingent obligation recognized has been de minimis. The estimated life and discount rate used to calculate the guaranty obligation are consistent with those used to calculate the corresponding MSR.

The MSR and associated guaranty obligation are amortized into expense over the estimated life of the loan. The MSR is amortized in proportion to, and over the period, that net servicing income is expected to be received. The guaranty obligation is amortized evenly over the same period. If a loan defaults and is not expected to become current or pays off prior to the estimated life, the unamortized MSR and guaranty obligation balances are expensed.

We carry the MSRs at the lower of amortized value or fair market value and evaluate the carrying value quarterly. We engage a third party to assist in valuing our MSRs on a semi-annual basis.

The Provision for Risk-Sharing Obligations. The amount of the provision considers our assessment of the likelihood of payment by the borrower or key principal(s), the estimated disposition value of the underlying collateral and the level of risk-sharing. Historically, initial loss recognition occurs at or before the loan becoming 60 days delinquent. We regularly monitor our risk-sharing obligations on all loans and update loss estimates as current information is received.

Goodwill and Other Intangible Assets. The Company accounts for business combinations using the acquisition method of accounting, under which the purchase price of the acquisition is allocated to the assets acquired and liabilities assumed using the fair values determined by management as of the acquisition date. The Company recognizes identifiable assets acquired, liabilities (both specific and contingent) assumed at their fair values at the acquisition date. Furthermore, acquisition-related costs, such as due diligence, legal and accounting fees, are not capitalized or applied in determining the fair value of the acquired assets.

We do not amortize goodwill; instead, we evaluate goodwill for impairment at least annually. In addition to our annual impairment evaluation, we evaluate whether events or circumstances have occurred in the period subsequent to our annual impairment testing which indicate that it is more likely than not an impairment loss has occurred. We evaluate our identified intangibles for impairment annually or if other events or circumstances indicate that the carrying value may be impaired.

Overview of Current Business Environment

In 2012, U.S. multifamily market fundamentals have continued their improvement following the macroeconomic instability experienced in recent years. Occupancy rates and effective rents appear to have increased based upon increased rental market demand, both of which aid loan performance due to their importance to the cash flows of the underlying properties. Despite this improvement in some market fundamentals, recovery of the overall real estate market continues to be challenged by the slow recovery of the broader economy.

The passage of Dodd-Frank introduced complex, comprehensive legislation into the financial and real estate recoveries, which will have far reaching effects on the industry and its participants. While we are not a banking institution, there is uncertainty as to how, in the coming years, Dodd-Frank may affect us or our competitors. In addition, the scope, extent and timing of GSE reform continues to be uncertain. Although we cannot predict what actions Congress or other governmental agencies may take affecting the GSEs and/or HUD, we

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expect some regulatory change is likely. In the interim, the GSEs and HUD continue to supply a significant level of capital to the multifamily market and are expected to continue to do so as commercial and multifamily debt refinancing activity is expected to increase.

Results of Operations

Following is a discussion of our results of operations for the three and nine months ended September 30, 2012 and 2011. The financial results are not necessarily indicative of future results. Our business is not typically subject to seasonal trends. However, our quarterly results have fluctuated in the past and are expected to fluctuate in the future, reflecting the interest rate environment, the volume of transactions and general economic conditions. Please refer to the table below, which provides supplemental data regarding our financial performance.

                                     For the three months ended         For the nine months ended
                                            September 30,                     September 30,
(Dollars in thousands)                   2012             2011             2012            2011
Origination Data:
Origination Volumes by Investor
Fannie Mae                         $      1,134,185    $   389,884    $    2,012,225    $ 1,248,972
Freddie Mac                                 552,971        178,787           860,779        443,218
Ginnie Mae - HUD                            228,135         57,746           438,056        422,331
Other (1)                                   265,504        280,250           881,174        609,025
Total                              $      2,180,795    $   906,667    $    4,192,234    $ 2,723,546

Key Metrics (as a percentage of
total revenues):
Personnel expenses                               46 %           34 %              40 %           32 %
Other operating expenses                         14 %           15 %              14 %           12 %
Total expenses                                   83 %           71 %              76 %           63 %
Operating margin                                 17 %           29 %              24 %           37 %

Key Origination Metrics (as a
percentage of origination
Origination related fees                       1.27 %         1.07 %            1.31 %         1.19 %
Fair value of MSRs created, net                1.18 %         1.31 %            1.24 %         1.37 %
Fair value of MSRs created, net
as a percentage of GSE and HUD
origination volume (2)                         1.34 %         1.90 %            1.57 %         1.77 %

                                             As of September 30,
                                             2012           2011
Servicing Portfolio by Type:
Fannie Mae                               $ 18,452,944   $ 10,136,692
Freddie Mac                                 8,422,748      2,715,788
Ginnie Mae - HUD                            4,422,182      1,262,989
Other (1)                                   2,588,688      1,825,330
Total                                    $ 33,886,562   $ 15,940,799

Key Servicing Metrics (end of period):
Weighted-average servicing fee rate              0.23 %         0.22 %

(1) CMBS, life insurance companies, commercial banks and interim loans. 2012 origination volume includes $29.8 million interim loan volume, which are classified as held for investment while outstanding.

(2) The fair value of the expected net future cash flows associated with the servicing of the loan, net of any guaranty obligation retained, as a percentage of GSE and HUD volume reflects revenue recognized, as a percentage of loan origination volume, on those loans which the Company will record an MSR upon sale of the loan. No MSRs are recorded on "Other" originations or interim loan originations. For the three and nine months ended September 30, 2012, interim loan volume was $13.3 and $29.8 million, respectively.

Non-GAAP Financial Measures

To supplement the condensed consolidated financial statements presented in accordance with U.S. generally accepted accounting principles, or GAAP, the Company presents the following non-GAAP financial measures:

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†          Adjusted net income;

†          Adjusted earnings per diluted share;

†          Adjusted total expenses;

†          Adjusted operating income; and

†          Adjusted operating margin.

These supplemental measures exclude acquisition and integration costs specifically related to the CWCapital acquisition, and amortization of customer contracts and other intangible assets acquired from CWCapital. The Company believes that these non-GAAP measures facilitate a review of the comparability of the Company's operating performance on a period-to-period basis because such costs are not, in our view, related to the Company's ongoing operational performance. We use non-GAAP measures to evaluate the operating performance of our business, for comparison with forecasts and strategic plans, and for benchmarking performance externally against competitors.

These non-GAAP measures are not in accordance with or an alternative for GAAP, and may be different from non-GAAP measures used by other companies. We believe that these non-GAAP measures have limitations in that they do not reflect all of the amounts associated with the Company's results of operations as determined in accordance with GAAP and that these measures should only be used to evaluate the Company's results of operations in conjunction with the corresponding GAAP measures. The presentation of this additional information is not meant to be considered in isolation or as a substitute for the most directly comparable GAAP measures.

Adjusted net income, adjusted earnings per diluted share, adjusted total expenses, adjusted operating income and adjusted operating margin are calculated as follows:

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                                              For the three months ended           For the nine months ended
(in thousands, except share and per                  September 30,                       September 30,
share amounts)                                   2012              2011              2012              2011

Reconciliation of GAAP Net Income and
GAAP Diluted Earnings Per Share to
Adjusted Net Income and Adjusted Diluted
Earnings Per Share
GAAP net income                             $        7,098    $        6,079    $        22,229    $      23,849
Shares (in 000s) (1)                                25,444            21,782             23,102           21,728
GAAP diluted earnings per share             $         0.28    $         0.28    $          0.96    $        1.10

GAAP net income                             $        7,098    $        6,079    $        22,229    $      23,849
Severance costs                             $        1,058    $            -    $         1,058    $           -
Amortization of intangibles                          7,353                 -              7,353                -
Transition services agreement                        1,000                 -              1,000                -
Deal-related expenses (2)                            2,334                 -              3,338                -
Income tax impact of adjustments                    (4,569 )                             (4,959 )              -
Adjusted net income                         $       14,274    $        6,079    $        30,019    $      23,849
Shares (in 000s) (1)                                25,444            21,782             23,102           21,728
Adjusted diluted earnings per share         $         0.56    $         0.28    $          1.30    $        1.10

Reconciliation of GAAP Income from
Operations and GAAP Operating Margin to
Adjusted Income from Operations and
Adjusted Operating Margin
GAAP income from operations                 $       11,778    $        9,652    $        36,381    $      38,735
Total revenues                                      70,126            33,356            151,248          104,759
GAAP operating margin                                   17 %              29 %               24 %             37 %

GAAP income from operations                 $       11,778    $        9,652    $        36,381    $      38,735
Severance costs                             $        1,058    $            -    $         1,058    $           -
Amortization of intangibles                          7,353                 -              7,353                -
Transition services agreement                        1,000                 -              1,000                -
Deal-related expenses (2)                            2,334                 -              3,338                -
Adjusted income from operations             $       23,523    $        9,652    $        49,130    $      38,735
Total revenues                                      70,126            33,356            151,248          104,759
Adjusted operating margin                               34 %              29 %               32 %             37 %

Reconciliation of GAAP Total Expenses to
Adjusted Total Expenses
GAAP total expenses                         $       58,348    $       23,704    $       114,867    $      66,024
. . .
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