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Section 1: 10-Q (10-Q)

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

 

 

 

    (Mark One)

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2019

OR

 

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to

Commission File Number: 001-35000

 

Walker & Dunlop, Inc.

 

(Exact name of registrant as specified in its charter)

 

Maryland

 

80-0629925

(State or other jurisdiction of

 

(I.R.S. Employer Identification No.)

incorporation or organization)

 

 

7501 Wisconsin Avenue, Suite 1200E

Bethesda, Maryland 20814

(301) 215-5500

(Address of principal executive offices and registrant’s telephone number, including area code)

 

Not Applicable

(Former name, former address, and former fiscal year if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

 

 

 

 

 

 

 

Large accelerated filer ☒ 

 

Smaller reporting company ☐

 

Accelerated filer ☐

Emerging growth company ☐

 

Non-accelerated filer ☐

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

 

As of April 24, 2019, there were 30,746,617 total shares of common stock outstanding.

 

 


 

Table of Contents

Walker & Dunlop, Inc.
Form 10-Q
INDEX

 

 

 

 

 

 

 

 

 

 

 

 

Page

 

 

 

 

PART I 

 

FINANCIAL INFORMATION

3

 

 

 

 

Item 1. 

 

Financial Statements

3

 

 

 

 

Item 2. 

 

Management's Discussion and Analysis of Financial Condition and Results of Operations

23

 

 

 

 

Item 3. 

 

Quantitative and Qualitative Disclosures About Market Risk

46

 

 

 

 

Item 4. 

 

Controls and Procedures

47

 

 

 

 

PART II 

 

OTHER INFORMATION

47

 

 

 

 

Item 1. 

 

Legal Proceedings

47

 

 

 

 

Item 1A. 

 

Risk Factors

47

 

 

 

 

Item 2. 

 

Unregistered Sales of Equity Securities and Use of Proceeds

47

 

 

 

 

Item 3. 

 

Defaults Upon Senior Securities

48

 

 

 

 

Item 4. 

 

Mine Safety Disclosures

48

 

 

 

 

Item 5. 

 

Other Information

48

 

 

 

 

Item 6. 

 

Exhibits

48

 

 

 

 

 

 

Signatures

50

 

 

 

 

 


 

Table of Contents

PART I

FINANCIAL INFORMATION

Item 1. Financial Statements

 

Walker & Dunlop, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(In thousands, except per share data)

 

 

 

 

 

 

 

 

 

 

March 31, 2019

    

December 31, 2018

 

Assets

 

(unaudited)

 

 

 

 

Cash and cash equivalents

 

$

109,862

 

$

90,058

 

Restricted cash

 

 

17,561

 

 

20,821

 

Pledged securities, at fair value

 

 

117,566

 

 

116,331

 

Loans held for sale, at fair value

 

 

1,226,380

 

 

1,074,348

 

Loans held for investment, net

 

 

471,561

 

 

497,291

 

Servicing fees and other receivables, net

 

 

52,643

 

 

50,419

 

Derivative assets

 

 

27,605

 

 

35,536

 

Mortgage servicing rights

 

 

677,946

 

 

670,146

 

Goodwill and other intangible assets

 

 

183,449

 

 

177,093

 

Other assets

 

 

84,320

 

 

50,014

 

Total assets

 

$

2,968,893

 

$

2,782,057

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

Accounts payable and other liabilities

 

$

306,515

 

$

312,949

 

Performance deposits from borrowers

 

 

17,471

 

 

20,335

 

Derivative liabilities

 

 

29,891

 

 

32,697

 

Guaranty obligation, net of accumulated amortization

 

 

49,376

 

 

46,870

 

Allowance for risk-sharing obligations

 

 

6,682

 

 

4,622

 

Warehouse notes payable

 

 

1,335,461

 

 

1,161,382

 

Note payable

 

 

295,425

 

 

296,010

 

Total liabilities

 

$

2,040,821

 

$

1,874,865

 

 

 

 

 

 

 

 

 

Equity

 

 

 

 

 

 

 

Preferred shares, authorized 50,000; none issued.

 

$

 —

 

$

 —

 

Common stock, $0.01 par value. Authorized 200,000; issued and outstanding 29,973 shares at March 31, 2019 and 29,497 shares at December 31, 2018.

 

 

300

 

 

295

 

Additional paid-in capital ("APIC")

 

 

223,742

 

 

235,152

 

Accumulated other comprehensive income (loss) ("AOCI")

 

 

226

 

 

(75)

 

Retained earnings

 

 

698,894

 

 

666,752

 

Total stockholders’ equity

 

$

923,162

 

$

902,124

 

Noncontrolling interests

 

 

4,910

 

 

5,068

 

Total equity

 

$

928,072

 

$

907,192

 

Commitments and contingencies (NOTES 2 and 10)

 

 

 —

 

 

 —

 

Total liabilities and equity

 

$

2,968,893

 

$

2,782,057

 

 

 

 

 

 

 

 

 

See accompanying notes to condensed consolidated financial statements.

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Walker & Dunlop, Inc. and Subsidiaries

Condensed Consolidated Statements of Income and Comprehensive Income

(In thousands, except per share data)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

For the three months ended

 

 

 

March 31, 

 

 

    

2019

    

2018

 

Revenues

 

 

 

 

 

 

 

Gains from mortgage banking activities

 

$

98,735

 

$

81,509

 

Servicing fees

 

 

52,199

 

 

48,040

 

Net warehouse interest income

 

 

7,021

 

 

1,857

 

Escrow earnings and other interest income

 

 

14,068

 

 

7,348

 

Other

 

 

15,414

 

 

8,698

 

Total revenues

 

$

187,437

 

$

147,452

 

 

 

 

 

 

 

 

 

Expenses

 

 

 

 

 

 

 

Personnel

 

$

71,631

 

$

55,273

 

Amortization and depreciation

 

 

37,903

 

 

33,635

 

Provision (benefit) for credit losses

 

 

2,675

 

 

(477)

 

Interest expense on corporate debt

 

 

3,652

 

 

2,179

 

Other operating expenses

 

 

15,492

 

 

12,951

 

Total expenses

 

$

131,353

 

$

103,561

 

Income from operations

 

$

56,084

 

$

43,891

 

Income tax expense

 

 

12,024

 

 

7,184

 

Net income before noncontrolling interests

 

$

44,060

 

$

36,707

 

Less: net income (loss) from noncontrolling interests

 

 

(158)

 

 

(154)

 

Walker & Dunlop net income

 

$

44,218

 

$

36,861

 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

Net change in unrealized gains and losses on pledged available-for-sale securities

 

 

301

 

 

(127)

 

Walker & Dunlop comprehensive income

 

$

44,519

 

$

36,734

 

 

 

 

 

 

 

 

 

Basic earnings per share (NOTE 11)

 

$

1.44

 

$

1.18

 

Diluted earnings per share (NOTE 11)

 

$

1.39

 

$

1.14

 

 

 

 

 

 

 

 

 

Basic weighted average shares outstanding

 

 

29,680

 

 

30,020

 

Diluted weighted average shares outstanding

 

 

30,684

 

 

31,128

 

 

 

 

 

 

 

 

 

See accompanying notes to condensed consolidated financial statements.

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Table of Contents

Walker & Dunlop, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

For the three months ended March 31, 

 

 

    

2019

    

2018

 

Cash flows from operating activities

 

 

 

 

 

 

 

Net income before noncontrolling interests

 

$

44,060

 

$

36,707

 

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

 

 

 

 

 

 

 

Gains attributable to the fair value of future servicing rights, net of guaranty obligation

 

 

(40,938)

 

 

(32,693)

 

Change in the fair value of premiums and origination fees

 

 

2,955

 

 

945

 

Amortization and depreciation

 

 

37,903

 

 

33,635

 

Provision (benefit) for credit losses

 

 

2,675

 

 

(477)

 

Originations of loans held for sale

 

 

(3,773,443)

 

 

(2,455,871)

 

Sales of loans to third parties

 

 

3,622,404

 

 

2,619,131

 

Other operating activities, net

 

 

(30,978)

 

 

(24,340)

 

Net cash provided by (used in) operating activities

 

$

(135,362)

 

$

177,037

 

 

 

 

 

 

 

 

 

Cash flows from investing activities

 

 

 

 

 

 

 

Capital expenditures

 

$

(1,461)

 

$

(516)

 

Purchases of pledged available-for-sale securities

 

 

(4,078)

 

 

(18,634)

 

Funding of preferred equity investments

 

 

 —

 

 

(1,100)

 

Distributions from (investments in) Interim Program JV

 

 

(1,679)

 

 

1,055

 

Acquisitions, net of cash received

 

 

(7,180)

 

 

 —

 

Originations of loans held for investment

 

 

(33,362)

 

 

(7,319)

 

Principal collected on loans held for investment upon payoff

 

 

60,145

 

 

14,126

 

Net cash provided by (used in) investing activities

 

$

12,385

 

$

(12,388)

 

 

 

 

 

 

 

 

 

Cash flows from financing activities

 

 

 

 

 

 

 

Borrowings (repayments) of warehouse notes payable, net

 

$

151,814

 

$

(124,705)

 

Borrowings of interim warehouse notes payable

 

 

21,976

 

 

 —

 

Repayments of interim warehouse notes payable

 

 

 —

 

 

(10,594)

 

Repayments of note payable

 

 

(750)

 

 

(276)

 

Proceeds from issuance of common stock

 

 

4,187

 

 

4,851

 

Repurchase of common stock

 

 

(24,159)

 

 

(21,400)

 

Cash dividends paid

 

 

(9,319)

 

 

(7,838)

 

Payment of contingent consideration

 

 

(6,450)

 

 

(5,150)

 

Debt issuance costs

 

 

(824)

 

 

(1,086)

 

Net cash provided by (used in) financing activities

 

$

136,475

 

$

(166,198)

 

 

 

 

 

 

 

 

 

Net increase (decrease) in cash, cash equivalents, restricted cash, and restricted cash equivalents (NOTE 2)

 

$

13,498

 

$

(1,549)

 

Cash, cash equivalents, restricted cash, and restricted cash equivalents at beginning of period

 

 

120,348

 

 

286,680

 

Total of cash, cash equivalents, restricted cash, and restricted cash equivalents at end of period

 

$

133,846

 

$

285,131

 

 

 

 

 

 

 

 

 

Supplemental Disclosure of Cash Flow Information:

 

 

 

 

 

 

 

Cash paid to third parties for interest

 

$

17,785

 

$

10,500

 

Cash paid for income taxes

 

 

372

 

 

805

 

 

See accompanying notes to condensed consolidated financial statements.

 

5


 

Table of Contents

NOTE 1—ORGANIZATION AND BASIS OF PRESENTATION

These financial statements represent the condensed consolidated financial position and results of operations of Walker & Dunlop, Inc. and its subsidiaries. Unless the context otherwise requires, references to “we,” “us,” “our,” “Walker & Dunlop” and the “Company” mean the Walker & Dunlop consolidated companies. The statements have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Regulation S-X. Accordingly, they may not include certain financial statement disclosures and other information required for annual financial statements. The accompanying condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018 (“2018 Form 10-K”). In the opinion of management, all adjustments (consisting only of normal recurring accruals except as otherwise noted herein) considered necessary for a fair presentation of the results for the Company in the interim periods presented have been included. Results of operations for the three months ended March 31, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019 or thereafter.

Walker & Dunlop, Inc. is a holding company and conducts the majority of its operations through Walker & Dunlop, LLC, the operating company. Walker & Dunlop is one of the leading commercial real estate services and finance companies in the United States. The Company originates, sells, and services a range of commercial real estate debt and equity financing products, provides property sales brokerage services with a specific focus on multifamily, and engages in commercial real estate investment management activities. Through its mortgage bankers and property sales brokers, the Company offers its customers Agency Lending, Debt Brokerage, and Principal Lending and Investing products and Multifamily Property Sales services.

Through its Agency Lending products, the Company originates and sells loans pursuant to the programs of the Federal National Mortgage Association (“Fannie Mae”), the Federal Home Loan Mortgage Corporation (“Freddie Mac,” and together with Fannie Mae, the “GSEs”), 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”. Through its Debt Brokerage products, the Company brokers, and in some cases services, loans for various life insurance companies, commercial banks, commercial mortgage backed securities issuers, and other institutional investors, in which cases the Company does not fund the loan.

The Company also provides a variety of commercial real estate finance and equity products through its Principal Lending and Investing products, including interim loans, preferred equity, and Joint Venture (“JV”) equity on commercial real estate properties. Interim loans on multifamily properties are offered (i) through the Company and recorded on the Company’s balance sheet (the “Interim Program”) and (ii) through a joint venture with an affiliate of Blackstone Mortgage Trust, Inc., in which the Company holds a 15% ownership interest (the “Interim Program JV”). Interim loans on all commercial real estate property types are offered through separate accounts managed by the Company’s subsidiary, JCR Capital Investment Corporation (“JCR”). Preferred equity and JV equity on commercial real estate properties are offered through funds managed by JCR.

The Company brokers the sale of multifamily properties through its 75% owned subsidiary, Walker & Dunlop Investment Sales (“WDIS”).

NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation—The condensed consolidated financial statements include the accounts of Walker & Dunlop, Inc., its wholly owned subsidiaries, and its majority owned subsidiaries. All intercompany transactions have been eliminated in consolidation. When the Company has significant influence over operating and financial decisions for an entity but does not have control over the entity or own a majority of the voting interests, the Company accounts for the investment using the equity method of accounting.

Subsequent Events—The Company has evaluated the effects of all events that have occurred subsequent to March 31, 2019. There have been no material events that would require recognition in the condensed consolidated financial statements. The Company has made certain disclosures in the notes to the condensed consolidated financial statements of events that have occurred subsequent to March 31, 2019. No other material subsequent events have occurred that would require disclosure.

Use of Estimates—The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses, including allowance for risk-sharing obligations, capitalized mortgage servicing rights, derivative instruments, and the disclosure of contingent liabilities. Actual results may vary from these estimates.

 

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Loans Held for Investment, netLoans held for investment are multifamily loans originated by the Company for properties that currently do not qualify for permanent GSE or HUD (collectively, the “Agencies”) financing. These loans have terms of generally up to three years and are all multifamily loans with similar risk characteristics. As of March 31, 2019, Loans held for investment, net consisted of 15 loans with an aggregate $476.8 million of unpaid principal balance less $4.4 million of net unamortized deferred fees and costs and $0.8 million of allowance for loan losses. As of December 31, 2018, Loans held for investment, net consisted of 14 loans with an aggregate $503.5 million of unpaid principal balance less $6.0 million of net unamortized deferred fees and costs and $0.2 million of allowance for loan losses. Included within the Loans held for investment, net balance as of March 31, 2019 and December 31, 2018 is a participation in a subordinated note with a large institutional investor in multifamily loans that was fully funded with corporate cash. The note is collateralized, in part, by a portfolio of multifamily loans and is scheduled to mature at the end of the third quarter of 2019. The unpaid principal balance of the participation was $132.6 million as of March 31, 2019 and $150.0 million as of December 31, 2018.

 

In the third quarter of 2018, the Company transferred a portfolio of participating interests in loans held for investment to a third party. The Company accounted for the transfer as a secured borrowing. The aggregate unpaid principal balance of the loans of $77.8 million is presented as a component of Loans held for investment, net in the Condensed Consolidated Balance Sheet as of March 31, 2019, and the secured borrowing of $70.1 million is included within Accounts payable and other liabilities in the Condensed Consolidated Balance Sheet as of March 31, 2019. The Company does not have credit risk related to the $70.1 million of loans that were transferred.

 

One loan held for investment with an unpaid principal balance of $14.7 million was delinquent, impaired, and on non-accrual status as of March 31, 2019. None of the loans held for investment was delinquent, impaired, or on non-accrual status as of December 31, 2018. Prior to 2019, the Company did not experience any delinquencies related to these loans. The Company has never charged off any loan held for investment. The allowances for loan losses recorded as of March 31, 2019 and December 31, 2018 were based on the Company’s collective assessment of the portfolio.

 

Provision (Benefit) for Credit Losses—The Company records the income statement impact of the changes in the allowance for loan losses and the allowance for risk-sharing obligations within Provision (benefit) for credit losses in the Condensed Consolidated Statements of Income. NOTE 5 contains additional discussion related to the allowance for risk-sharing obligations. Provision (benefit) for credit losses consisted of the following activity for the three months ended March 31, 2019 and 2018:

 

 

 

 

 

 

 

 

 

 

 

For the three months ended 

 

 

 

March 31, 

 

Components of Provision (benefit) for Credit Losses (in thousands)

    

2019

    

2018

 

Provision (benefit) for loan losses

 

$

623

 

$

(14)

 

Provision (benefit) for risk-sharing obligations

 

 

2,052

 

 

(463)

 

Provision (benefit) for credit losses

 

$

2,675

 

$

(477)

 

 

 

 

 

 

 

 

 

Net Warehouse Interest Income—The Company presents warehouse interest income net of warehouse interest expense. Warehouse interest income is the interest earned from loans held for sale and loans held for investment. Substantially all loans that are held for sale are financed with matched borrowings under our warehouse facilities incurred to fund a specific loan held for sale. A portion of loans held for investment is typically financed with matched borrowings under our warehouse facilities. The portion of loans held for sale or investment not funded with matched borrowings is financed with the Company’s own cash. On occasion, the Company may fully fund a limited number of loans held for sale or loans held for investment with corporate cash. Warehouse interest expense is incurred on borrowings used to fund loans solely while they are held for sale or for investment. Warehouse interest income and expense are earned or incurred on loans held for sale after a loan is closed and before a loan is sold. Warehouse interest income and expense are earned or incurred on loans held for investment during the period of time the loan is outstanding. Included in Net warehouse interest income for the three months ended March 31, 2019 and 2018 are the following components:

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For the three months ended 

 

 

 

March 31, 

 

Components of Net Warehouse Interest Income (in thousands)

    

2019

    

2018

 

Warehouse interest income - loans held for sale

 

$

13,984

 

$

8,763

 

Warehouse interest expense - loans held for sale

 

 

(13,955)

 

 

(7,655)

 

Net warehouse interest income - loans held for sale

 

$

29

 

$

1,108

 

 

 

 

 

 

 

 

 

Warehouse interest income - loans held for investment

 

$

9,667

 

$

1,422

 

Warehouse interest expense - loans held for investment

 

 

(2,675)

 

 

(673)

 

Warehouse interest income - secured borrowings

 

 

888

 

 

 —

 

Warehouse interest expense - secured borrowings

 

 

(888)

 

 

 —

 

Net warehouse interest income - loans held for investment

 

$

6,992

 

$

749

 

 

 

 

 

 

 

 

 

Total net warehouse interest income

 

$

7,021

 

$

1,857

 

 

 

 

 

 

 

 

 

Income Taxes—The Company records the realizable excess tax benefits from stock compensation as a reduction to income tax expense. The Company recorded realizable excess tax benefits of $3.4 million and $4.1 million during the three months ended March 31, 2019 and 2018, respectively.

 

Statement of Cash Flows—For presentation in the Condensed Consolidated Statements of Cash Flows, the Company considers pledged cash and cash equivalents (as detailed in NOTE 10) to be restricted cash and restricted cash equivalents. The following table, in conjunction with the detail of Pledged securities, at fair value presented in NOTE 10, presents a reconciliation of the total of cash, cash equivalents, restricted cash, and restricted cash equivalents as presented in the Condensed Consolidated Statements of Cash Flows to the related captions in the Condensed Consolidated Balance Sheets as of March 31, 2019 and 2018 and December 31, 2018 and 2017.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 

 

December 31,

 

(in thousands)

2019

    

2018

    

2018

    

2017

 

Cash and cash equivalents

$

109,862

 

$

193,695

 

$

90,058

 

$

191,218

 

Restricted cash

 

17,561

 

 

16,991

 

 

20,821

 

 

6,677

 

Pledged cash and cash equivalents

 

6,423

 

 

74,445

 

 

9,469

 

 

88,785

 

Total cash, cash equivalents, restricted cash, and restricted cash equivalents

$

133,846

 

$

285,131

 

$

120,348

 

$

286,680

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Contracts with Customers—The majority of the Company’s revenues are derived from the following sources, all of which are excluded from the accounting provisions applicable to contracts with customers: (i) financial instruments, (ii) transfers and servicing, (iii) derivative transactions, and (iv) investments in debt securities/equity-method investments. The remaining portion of revenues is derived from contracts with customers. The Company’s contracts with customers do not require significant judgment or material estimates that affect the determination of the transaction price (including the assessment of variable consideration), the allocation of the transaction price to performance obligations, and the determination of the timing of the satisfaction of performance obligations. Additionally, the earnings process for the Company’s contracts with customers is not complicated and is generally completed in a short period of time. The Company had no contract assets or liabilities as of March 31, 2019 and December 31, 2018. The following table presents information about the Company’s contracts with customers for the three months ended March 31, 2019 and 2018:

 

 

 

 

 

 

 

 

 

 

 

 

For the three months ended 

 

 

 

 

March 31, 

 

 

Description (in thousands)

    

2019

    

2018

 

Statement of income line item

Certain loan origination fees

 

$

11,531

 

$

11,285

 

Gains from mortgage banking activities

Property sales broker fees, investment management fees, assumption fees, application fees, and other

 

 

8,961

 

 

4,325

 

Other revenues

Total revenues derived from contracts with customers

 

$

20,492

 

$

15,610

 

 

 

 

 

 

 

 

 

 

 

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Litigation—In the ordinary course of business, the Company may be party to various claims and litigation, none of which the Company believes is material. The Company cannot predict the outcome of any pending litigation and may be subject to consequences that could include fines, penalties, and other costs, and the Company’s reputation and business may be impacted. The Company believes that any liability that could be imposed on the Company in connection with the disposition of any pending lawsuits would not have a material adverse effect on its business, results of operations, liquidity, or financial condition.

 

Recently Adopted and Recently Announced Accounting PronouncementsIn the first quarter of 2016, Accounting Standards Update 2016-02 (“ASU 2016-02”), Leases (Topic 842) was issued. ASU 2016-02 represents a significant reform to the accounting for leases. Lessees initially recognize a lease liability for the obligation to make lease payments and a right-of-use (“ROU”) asset for the right to use the underlying asset for the lease term. The lease liability is measured at the present value of the lease payments over the lease term. The ROU asset is measured at the lease liability amount, adjusted for lease prepayments, accrued rent, lease incentives received, and the lessee’s initial direct costs. Lessees generally recognize lease expense for these leases on a straight-line basis, which is similar to the previous accounting treatment. ASU 2016-02 requires additional disclosures and requires one of two adoption approaches: (i) modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements with a cumulative-effect adjustment to retained earnings recorded at the earliest comparative period or (ii) prospective approach with a cumulative-effect adjustment recorded to retained earnings upon the date of adoption.

 

The Company adopted the standard as required on January 1, 2019 and elected the available practical expedients that were applicable to the Company and the prospective approach. There was no change to the classification of the Company’s leases, which are all currently classified as operating leases. NOTE 12 contains additional detail about the impact ASU 2016-02 had on the Company’s financial position and results of operations.

In the third quarter of 2018, Accounting Standards Update 2018-15 (“ASU 2018-15”), Intangibles — Goodwill and Other — Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract was issued. ASU 2018-15 requires a customer in a cloud computing arrangement that is a service contract to follow the internal-use software guidance to determine which implementation costs to capitalize as assets. Capitalized implementation costs are amortized over the term of the hosting arrangement, and the expense related to the capitalized implementation costs is recorded in the same line in the financial statements as the cloud service cost. The Company early-adopted ASU 2018-15 on January 1, 2019 using the prospective approach. During the first quarter of 2019, the Company capitalized $1.9 million of implementation costs. Amortization of these costs has not begun as the Company has not placed the hosting arrangements into service.

In the second quarter of 2016, Accounting Standards Update 2016-13 (“ASU 2016-13”), Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments was issued. ASU 2016-13 ("the Standard") represents a significant change to the incurred loss model currently used to account for credit losses. The Standard requires an entity to estimate the credit losses expected over the life of the credit exposure upon initial recognition of that exposure. The expected credit losses consider historical information, current information, and reasonable and supportable forecasts, including estimates of prepayments. Exposures with similar risk characteristics are required to be grouped together when estimating expected credit losses. The initial estimate and subsequent changes to the estimated credit losses are required to be reported in current earnings in the income statement and through an allowance in the balance sheet. ASU 2016-13 is applicable to financial assets subject to credit losses and measured at amortized cost and certain off-balance-sheet credit exposures. The Standard will modify the way the Company estimates its allowance for risk-sharing obligations and its allowance for loan losses and the way it assesses impairment on its pledged available-for-sale (“AFS”) securities. ASU 2016-13 requires modified retrospective application to all outstanding, in-scope instruments, with a cumulative-effect adjustment recorded to opening retained earnings as of the beginning of the period of adoption.

 

The Company plans on adopting ASU 2016-13 when the standard is required to be adopted, January 1, 2020. The Company is in the process of determining the significance of the impact the Standard will have on its financial statements. The Company expects its allowance for risk-sharing obligations to increase when ASU 2016-13 is adopted.

 

There are no other accounting pronouncements previously issued by the FASB but not yet effective or not yet adopted by the Company that have the potential to materially impact the Company’s condensed consolidated financial statements.

There have been no material changes to the accounting policies discussed in NOTE 2 of the Company’s 2018 Form 10-K.

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Immaterial Correction of an Error—In the fourth quarter of 2018, the Company identified  and corrected an immaterial error in the way earnings per share were calculated for quarterly and annual financial results presented in its previous filings. The Company’s 2018 Form 10-K contains additional detail related to the correction of the immaterial error. This Quarterly Report on Form 10-Q presents the corrected basic and diluted earnings per share for the three months ended March 31, 2018.

ReclassificationsThe Company has made certain immaterial reclassifications to prior-year balances to conform to current-year presentation.

NOTE 3—GAINS FROM MORTGAGE BANKING ACTIVITIES

Gains from mortgage banking activities consisted of the following activity for the three months ended March 31, 2019 and 2018:

 

 

 

 

 

 

 

 

 

March 31, 

 

Components of Gains from Mortgage Banking Activities (in thousands)

2019

    

2018

 

Contractual loan origination related fees, gross

$

60,653

 

$

54,384

 

Co-broker fees

 

(2,856)

 

 

(5,568)

 

Fair value of expected net cash flows from servicing recognized at commitment

 

45,035

 

 

35,228

 

Fair value of expected guaranty obligation recognized at commitment

 

(4,097)

 

 

(2,535)

 

Total gains from mortgage banking activities

$

98,735

 

$

81,509

 

 

 

 

 

 

 

 

 

NOTE 4—MORTGAGE SERVICING RIGHTS

Mortgage servicing rights (“MSRs”) represent the carrying value of the commercial servicing rights retained by the Company for mortgage loans originated and sold and MSRs acquired from third parties. The initial capitalized amount is equal to the estimated fair value of the expected net cash flows associated with the servicing rights. MSRs are amortized using the interest method over the period that servicing income is expected to be received. The Company has one class of MSRs.

The fair values of the MSRs at March 31, 2019 and December 31, 2018 were $867.8 million and $858.7 million, respectively. The Company uses a discounted static cash flow valuation approach, and the key economic assumption is the discount rate. For example, see the following sensitivities:

The impact of a 100-basis point increase in the discount rate at March 31, 2019 is a decrease in the fair value of $27.2 million.

The impact of a 200-basis point increase in the discount rate at March 31, 2019 is a decrease in the fair value of $52.6 million.

These sensitivities are hypothetical and should be used with caution. These hypothetical scenarios do not include interplay among assumptions and are estimated as a portfolio rather than individual assets.

Activity related to capitalized MSRs for the three months ended March 31, 2019 and 2018 is shown in the table below:

 

 

 

 

 

 

 

 

 

 

For the three months ended

 

 

 

March 31, 

 

Roll Forward of MSRs (in thousands)

    

2019

    

2018

 

Beginning balance

 

$

670,146

 

$

634,756

 

Additions, following the sale of loan

 

 

47,102

 

 

30,922

 

Amortization

 

 

(34,203)

 

 

(32,161)

 

Pre-payments and write-offs

 

 

(5,099)

 

 

(2,486)

 

Ending balance

 

$

677,946

 

$

631,031

 

 

 

 

 

 

 

 

 

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The following tables summarize the gross value, accumulated amortization, and net carrying value of the Company’s acquired and originated commercial MSRs as of March 31, 2019 and December 31, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of March 31, 2019

 

 

  

Gross

  

Accumulated

  

Net

 

(in thousands)

 

value

 

  amortization  

 

  carrying value  

 

Acquired MSRs

 

$

185,529

 

$

(139,805)

 

$

45,724

 

Originated MSRs

 

 

934,420

 

 

(302,198)

 

 

632,222

 

Total

 

$

1,119,949

 

$

(442,003)

 

$

677,946

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 2018

 

 

  

Gross

  

Accumulated

  

Net

 

(in thousands)

 

value

 

  amortization  

 

  carrying value  

 

Acquired MSRs

 

$

185,529

 

$

(136,929)

 

$

48,600

 

Originated MSRs

 

 

914,910

 

 

(293,364)

 

 

621,546

 

Total

 

$

1,100,439

 

$

(430,293)

 

$

670,146

 

 

 

 

 

 

 

 

 

 

 

 

The expected amortization of MSRs recorded as of March 31, 2019 is shown in the table below. Actual amortization may vary from these estimates.

 

 

 

 

 

 

 

 

 

 

 

 

 

  

Originated MSRs

  

Acquired MSRs

  

Total MSRs

 

(in thousands)

 

Amortization

 

Amortization

 

  Amortization  

 

Nine Months Ending December 31, 

 

 

 

 

 

 

 

 

 

 

2019

 

$

90,131

 

$

7,296

 

$

97,427

 

Year Ending December 31, 

 

 

 

 

 

 

 

 

 

 

2020

 

$

109,244

 

$

8,801

 

$

118,045

 

2021

 

 

96,362

 

 

7,546

 

 

103,908

 

2022

 

 

82,984

 

 

5,886

 

 

88,870

 

2023

 

 

71,519

 

 

5,122

 

 

76,641

 

2024

 

 

59,162

 

 

4,573

 

 

63,735

 

Thereafter

 

 

122,820

 

 

6,500

 

 

129,320

 

Total

 

$

632,222

 

$

45,724

 

$

677,946

 

 

 

 

 

 

 

 

 

 

 

 

 

NOTE 5—GUARANTY OBLIGATION AND ALLOWANCE FOR RISK-SHARING OBLIGATIONS

When a loan is sold under the Fannie Mae Delegated Underwriting and ServicingTM (“DUS”) program, the Company typically agrees to guarantee a portion of the ultimate loss incurred on the loan should the borrower fail to perform. The compensation for this risk is a component of the servicing fee on the loan. The guaranty is in force while the loan is outstanding. The Company does not provide a guaranty for any other loan product it sells or brokers.

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Activity related to the guaranty obligation for the three months ended March 31, 2019 and 2018 is presented in the following table:

 

 

 

 

 

 

 

 

 

 

 

For the three months ended

 

 

 

March 31, 

 

Roll Forward of Guaranty Obligation (in thousands)

    

2019

    

2018

 

Beginning balance

 

$

46,870

 

$

41,187

 

Additions, following the sale of loan

 

 

4,863

 

 

1,783

 

Amortization

 

 

(2,349)

 

 

(1,808)

 

Other

 

 

(8)

 

 

262

 

Ending balance

 

$

49,376

 

$

41,424

 

 

 

 

 

 

 

 

 

Activity related to the allowance for risk-sharing obligations for the three months ended March 31, 2019 and 2018 is shown in the following table:

 

 

 

 

 

 

 

 

 

 

For the three months ended

 

 

 

March 31, 

 

Roll Forward of Allowance for Risk-sharing Obligations (in thousands)

    

2019

    

2018

 

Beginning balance

 

$

4,622

 

$

3,783

 

Provision (benefit) for risk-sharing obligations

 

 

2,052

 

 

(463)

 

Write-offs

 

 

 —

 

 

 

Other

 

 

 8

 

 

(262)

 

Ending balance

 

$

6,682

 

$

3,058

 

 

 

 

 

 

 

 

 

When the Company places a loan for which it has a risk-sharing obligation on its watch list, the Company transfers the remaining unamortized balance of the guaranty obligation to the allowance for risk-sharing obligations. When a loan for which the Company has a risk-sharing obligation is removed from the watch list, the loan’s reserve is transferred from the allowance for risk-sharing obligations back to the guaranty obligation, and the amortization of the remaining balance over the remaining estimated life is resumed. This net transfer of the unamortized balance of the guaranty obligation from a noncontingent classification to a contingent classification (and vice versa) is presented in the guaranty obligation and allowance for risk-sharing obligations tables above as “Other.”

The Allowance for risk-sharing obligations as of March 31, 2019 is based largely on the Company’s collective assessment of the probability of loss related to the loans on the watch list as of March 31, 2019. As of March 31, 2019, the maximum quantifiable contingent liability associated with the Company’s guarantees under the Fannie Mae DUS agreement was $7.0 billion. The maximum quantifiable contingent liability is not representative of the actual loss the Company would incur. The Company would be liable for this amount only if all of the loans it services for Fannie Mae, for which the Company retains some risk of loss, were to default and all of the collateral underlying these loans were determined to be without value at the time of settlement.

NOTE 6—SERVICING

The total unpaid principal balance of the Company’s servicing portfolio was $87.7 billion as of March 31, 2019 compared to $85.7 billion as of December 31, 2018.

As of March 31, 2019 and December 31, 2018, custodial escrow accounts relating to loans serviced by the Company totaled $2.0 billion and $2.3 billion, respectively. These amounts are not included in the accompanying consolidated balance sheets as such amounts are not Company assets. Certain cash deposits at other financial institutions exceed the Federal Deposit Insurance Corporation insured limits. The Company places these deposits with financial institutions that meet the requirements of the Agencies and where it believes the risk of loss to be minimal.

NOTE 7—WAREHOUSE NOTES PAYABLE

At March 31, 2019, to provide financing to borrowers, the Company has arranged for warehouse lines of credit. In support of the Agencies’ programs, the Company has committed and uncommitted warehouse lines of credit in the amount of $2.7 billion with certain national banks and a $1.5 billion uncommitted facility with Fannie Mae (collectively, the “Agency Warehouse Facilities”). The Company

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has pledged substantially all of its loans held for sale against the Agency Warehouse Facilities. The Company has arranged for warehouse lines of credit in the amount of $0.4 billion with certain national banks to assist in funding loans held for investment under the Interim Program (“Interim Warehouse Facilities”). The Company has pledged all of its loans held for investment for which funding is obtained against these Interim Warehouse Facilities. The maximum amount and outstanding borrowings under the warehouse notes payable at March 31, 2019 are shown in the table below:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2019

 

 

 

(dollars in thousands)

    

Committed

    

Uncommitted

 

Total Facility

 

Outstanding

    

    

 

Facility1

 

Amount

 

Amount

 

Capacity

 

Balance

 

Interest rate

 

Agency Warehouse Facility #1

 

$

425,000

 

$

200,000

 

$

625,000

 

$

91,942

 

30-day LIBOR plus 1.20%

 

Agency Warehouse Facility #2

 

 

500,000

 

 

300,000

 

 

800,000

 

 

414,696

 

30-day LIBOR plus 1.20%

 

Agency Warehouse Facility #3

 

 

500,000

 

 

 —

 

 

500,000

 

 

258,276

 

30-day LIBOR plus 1.25%

 

Agency Warehouse Facility #4

 

 

350,000

 

 

 —

 

 

350,000

 

 

166,563

 

30-day LIBOR plus 1.20%

 

Agency Warehouse Facility #5

 

 

30,000

 

 

 —

 

 

30,000

 

 

12,469

 

30-day LIBOR plus 1.80%

 

Agency Warehouse Facility #6

 

 

250,000

 

 

100,000

 

 

350,000

 

 

162,253

 

30-day LIBOR plus 1.20%

 

Fannie Mae repurchase agreement, uncommitted line and open maturity

 

 

 —

 

 

1,500,000

 

 

1,500,000

 

 

78,867

 

30-day LIBOR plus 1.15%

 

Total Agency Warehouse Facilities

 

$

2,055,000

 

$

2,100,000

 

$

4,155,000

 

$

1,185,066

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interim Warehouse Facility #1

 

$

135,000

 

$

 —

 

$

135,000

 

$

68,390

 

30-day LIBOR plus 1.90%

 

Interim Warehouse Facility #2

 

 

100,000

 

 

 —

 

 

100,000

 

 

37,900

 

30-day LIBOR plus 2.00%

 

Interim Warehouse Facility #3

 

 

75,000

 

 

 —

 

 

75,000

 

 

45,225

 

30-day LIBOR plus 1.90% to 2.50%

 

Interim Warehouse Facility #4

 

 

100,000

 

 

 —

 

 

100,000

 

 

 —

 

30-day LIBOR plus 1.75%

 

Total Interim Warehouse Facilities

 

$

410,000

 

$

 —

 

$

410,000

 

$

151,515

 

 

 

Debt issuance costs

 

 

 —

 

 

 —

 

 

 —

 

 

(1,120)

 

 

 

Total warehouse facilities

 

$

2,465,000

 

$

2,100,000

 

$

4,565,000

 

$

1,335,461

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


1 Agency Warehouse Facilities, including the Fannie Mae repurchase agreement are used to fund loans held for sale, while Interim Warehouse Facilities are used to fund loans held for investment.


 

During the second quarter of 2019, the Company executed the tenth amendment to the warehouse agreement related to Agency Warehouse Facility #3. The amendment extended the maturity date to April 30, 2020 and decreased the borrowing rate to 30-day London Interbank Offered Rate (“LIBOR”) plus 115 basis points. No other material modifications have been made to the agreement during 2019.

 

During the first quarter of 2019, the Company executed the second amendment to the warehouse agreement related to Agency Warehouse Facility #6. The amendment extended the maturity date to January 31, 2020. No other material modifications have been made to the agreement during 2019.

 

During the first quarter of 2019, the Company executed the ninth amendment to the credit and security agreement related to Interim Warehouse Facility #1 that increased the maximum borrowing capacity to $135.0 million. During the second quarter of 2019, the Company executed the tenth amendment to the credit and security agreement that extended the maturity date to April 30, 2020. No other material modifications have been made to the agreement during 2019.

 

During the first quarter of 2019, the Company executed a warehousing credit and security agreement to establish Interim Warehouse Facility #4. The warehouse facility has a committed $100.0 million maximum borrowing amount.  The Company can fund certain interim loans to a specific large institutional borrower, and the borrowings under the warehouse agreement bear interest at a rate of 30-day LIBOR plus 175 basis points. During the second quarter of 2019, the Company executed the first amendment to the warehousing credit and security agreement that extended the maturity date to April 30, 2020. No other material modifications have been made to the agreement during 2019.

 

The warehouse notes payable are subject to various financial covenants, all of which the Company was in compliance with as of the current period end.

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NOTE 8—GOODWILL AND OTHER INTANGIBLE ASSETS

 

Activity related to goodwill for the three months ended March 31, 2019 and 2018 follows:

 

 

 

 

 

 

 

 

 

 

For the three months ended

 

 

 

March 31, 

 

Roll Forward of Goodwill (in thousands)

    

2019

    

2018

 

Beginning balance

 

$

173,904

 

$

123,767

 

Additions from acquisitions

 

 

6,520

 

 

 —

 

Impairment

 

 

 —

 

 

 —

 

Ending balance

 

$

180,424

 

$

123,767

 

 

 

 

 

 

 

 

 

The additions from acquisitions during the three months ended March 31, 2019 shown in the table above relates to an immaterial acquisition of a technology company that has developed automated solutions for parts of the loan underwriting process. Substantially all of the value associated with this acquisition related to its assembled workforce, resulting in substantially all of the consideration paid being considered goodwill. The Company expects none of the goodwill to be tax deductible. Total revenues and income from operations since the acquisition and the pro-forma incremental revenues and earnings related to the acquired entities as if the acquisition had occurred as of January 1, 2018 are immaterial. As of March 31, 2019 and December 31, 2018, the balance of intangible assets acquired from acquisitions totaled $3.0 million and $3.2 million, respectively. The weighted-average period over which the Company expects the intangible assets to be amortized is 5.3 years.

 

A summary of the Company’s contingent consideration, which is included in Accounts payable and other liabilities, as of and for the three months ended March 31, 2019 and 2018 follows:

 

 

 

 

 

 

 

 

 

 

For the three months ended

 

 

 

March 31, 

 

Roll Forward of Contingent Consideration (in thousands)

    

2019

    

2018

 

Beginning balance

 

$

11,630

 

$

14,091

 

Accretion

 

 

143

 

 

231

 

Payments