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Section 1: 10-Q (10-Q)

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Table of Contents

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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 September 30, 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)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Trading Symbol

Name of each exchange on which registered

Common Stock, $0.01 Par Value Per Share

WD

New York Stock Exchange

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 October 30, 2019, there were 30,817,298 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

26

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

51

Item 4.

Controls and Procedures

52

PART II

OTHER INFORMATION

53

Item 1.

Legal Proceedings

53

Item 1A.

Risk Factors

53

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

54

Item 3.

Defaults Upon Senior Securities

54

Item 4.

Mine Safety Disclosures

54

Item 5.

Other Information

54

Item 6.

Exhibits

54

Signatures

56

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)

September 30, 2019

    

December 31, 2018

Assets

(unaudited)

 

Cash and cash equivalents

$

65,641

$

90,058

Restricted cash

 

9,138

 

20,821

Pledged securities, at fair value

 

120,302

 

116,331

Loans held for sale, at fair value

 

1,259,075

 

1,074,348

Loans held for investment, net

 

454,430

 

497,291

Servicing fees and other receivables, net

 

56,149

 

50,419

Derivative assets

 

25,554

 

35,536

Mortgage servicing rights

 

697,350

 

670,146

Goodwill and other intangible assets

 

183,122

 

177,093

Other assets

 

110,240

 

50,014

Total assets

$

2,981,001

$

2,782,057

Liabilities

Accounts payable and other liabilities

$

335,119

$

312,949

Performance deposits from borrowers

 

8,711

 

20,335

Derivative liabilities

 

17,726

 

32,697

Guaranty obligation, net of accumulated amortization

 

52,656

 

46,870

Allowance for risk-sharing obligations

 

7,256

 

4,622

Warehouse notes payable

 

1,263,036

 

1,161,382

Note payable

 

294,255

 

296,010

Total liabilities

$

1,978,759

$

1,874,865

Equity

Preferred shares, authorized 50,000; none issued.

$

$

Common stock, $0.01 par value. Authorized 200,000; issued and outstanding 29,957 shares at September 30, 2019 and 29,497 shares at December 31, 2018.

 

300

 

295

Additional paid-in capital ("APIC")

 

231,297

 

235,152

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

1,015

(75)

Retained earnings

 

763,195

 

666,752

Total stockholders’ equity

$

995,807

$

902,124

Noncontrolling interests

 

6,435

 

5,068

Total equity

$

1,002,242

$

907,192

Commitments and contingencies (NOTES 2 and 10)

 

 

Total liabilities and equity

$

2,981,001

$

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

For the nine months ended

September 30, 

September 30, 

    

2019

    

2018

    

2019

    

2018

 

Revenues

Gains from mortgage banking activities

$

115,929

$

99,170

$

321,545

$

282,916

Servicing fees

 

54,219

 

50,781

 

159,424

 

148,138

Net warehouse interest income

 

6,172

 

3,880

 

19,604

 

8,129

Escrow earnings and other interest income

 

15,163

 

11,938

 

43,847

 

28,562

Other

 

20,784

 

18,888

 

55,609

 

42,568

Total revenues

$

212,267

$

184,657

$

600,029

$

510,313

Expenses

Personnel

$

93,057

$

79,776

$

249,086

$

206,475

Amortization and depreciation

37,636

36,739

112,920

105,863

Provision (benefit) for credit losses

 

(772)

 

519

 

2,864

 

842

Interest expense on corporate debt

 

3,638

 

2,429

 

11,067

 

6,951

Other operating expenses

 

19,393

 

14,535

 

51,715

 

42,662

Total expenses

$

152,952

$

133,998

$

427,652

$

362,793

Income from operations

$

59,315

$

50,659

$

172,377

$

147,520

Income tax expense

 

15,246

 

12,902

 

42,102

 

32,023

Net income before noncontrolling interests

$

44,069

$

37,757

$

130,275

$

115,497

Less: net income (loss) from noncontrolling interests

 

26

 

41

 

(182)

 

(192)

Walker & Dunlop net income

$

44,043

$

37,716

$

130,457

$

115,689

Other comprehensive income (loss), net of tax:

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

123

16

1,090

(164)

Walker & Dunlop comprehensive income

$

44,166

$

37,732

$

131,547

$

115,525

Basic earnings per share (NOTE 11)

$

1.42

$

1.20

$

4.22

$

3.69

Diluted earnings per share (NOTE 11)

$

1.39

$

1.15

$

4.11

$

3.56

Basic weighted average shares outstanding

 

29,987

 

30,423

 

29,885

 

30,234

Diluted weighted average shares outstanding

 

30,782

 

31,606

 

30,742

 

31,401

See accompanying notes to condensed consolidated financial statements.

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Walker & Dunlop, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

For the nine months ended September 30, 

 

    

2019

    

2018

 

Cash flows from operating activities

Net income before noncontrolling interests

$

130,275

$

115,497

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

 

(132,995)

 

(119,313)

Change in the fair value of premiums and origination fees

 

920

 

(2,226)

Amortization and depreciation

 

112,920

 

105,863

Provision (benefit) for credit losses

 

2,864

 

842

Originations of loans held for sale

(12,098,180)

(10,472,456)

Sales of loans to third parties

11,910,016

9,281,943

Other operating activities, net

(18,848)

(7,608)

Net cash provided by (used in) operating activities

$

(93,028)

$

(1,097,458)

Cash flows from investing activities

Capital expenditures

$

(4,166)

$

(1,965)

Purchases of pledged available-for-sale ("AFS") securities

(25,611)

(60,088)

Proceeds from prepayment of pledged debt AFS securities

18,116

Funding of preferred equity investments

(1,100)

Proceeds from the payoff of preferred equity investments

30,624

Distributions from (investments in) joint ventures, net

(10,377)

(890)

Acquisitions, net of cash received

(7,180)

(33,102)

Purchase of mortgage servicing rights

(1,814)

Originations of loans held for investment

 

(154,302)

 

(225,369)

Principal collected on loans held for investment upon payoff

 

200,315

 

87,688

Net cash provided by (used in) investing activities

$

16,795

$

(206,016)

Cash flows from financing activities

Borrowings (repayments) of warehouse notes payable, net

$

53,372

$

1,228,850

Borrowings of interim warehouse notes payable

 

85,678

 

50,455

Repayments of interim warehouse notes payable

 

(38,527)

 

(61,049)

Repayments of note payable

 

(2,250)

 

(828)

Proceeds from issuance of common stock

 

4,453

 

8,939

Repurchase of common stock

 

(29,850)

 

(26,712)

Cash dividends paid

(27,936)

(23,600)

Payment of contingent consideration

(6,450)

(5,150)

Debt issuance costs

 

(2,465)

 

(2,550)

Secured borrowings

70,052

Net cash provided by (used in) financing activities

$

36,025

$

1,238,407

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

$

(40,208)

$

(65,067)

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

$

80,140

$

221,613

Supplemental Disclosure of Cash Flow Information:

Cash paid to third parties for interest

$

51,085

$

35,315

Cash paid for income taxes

33,665

37,168

See accompanying notes to condensed consolidated financial statements.

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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 and nine months ended September 30, 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 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 debt and equity solutions 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 also 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 majority-owned subsidiary, Walker & Dunlop Investment Sales (“WDIS”). In some cases, the Company also provides the debt financing for the property sale.

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. In instances where the Company owns less than 100% of the equity interests of an entity but owns a majority of the voting interests or has control over an entity, the Company accounts for the portion of equity not attributable to Walker & Dunlop, Inc. as Noncontrolling interests in the balance sheet and the portion of net income not attributable to Walker & Dunlop, Inc. as Net income from noncontrolling interests in the income statement.

Subsequent Events—The Company has evaluated the effects of all events that have occurred subsequent to September 30, 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 September 30, 2019. No other material subsequent events have occurred that would require disclosure.

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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 and derivative instruments. Actual results may vary from these estimates.

Loans Held for Investment, net—Loans 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 September 30, 2019, Loans held for investment, net consisted of 16 loans with an aggregate $457.5 million of unpaid principal balance less $2.2 million of net unamortized deferred fees and costs and $0.9 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 September 30, 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 fourth quarter of 2019. The unpaid principal balance of the participation was $84.3 million as of September 30, 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 that is scheduled to mature in the third quarter of 2021. 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 Sheets as of September 30, 2019 and  December 31, 2018, and the secured borrowing of $70.1 million is included within Accounts payable and other liabilities in the Condensed Consolidated Balance Sheets as of September 30, 2019 and December 31, 2018. 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 September 30, 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 had not experienced 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 September 30, 2019 consisted primarily of the specific reserve on the impaired loan, while the allowance for loan losses as of December 31, 2018 was based on the Company’s collective assessment of the portfolio.

During the second quarter of 2019, the delinquent loan mentioned above experienced a maturity default. During the third quarter of 2019, a plan was agreed upon to recapitalize the project, bring in new property management, and extend the delinquent loan to allow the sponsor to correct weaknesses in the property. The Company expects to complete the restructuring of the loan later in the fourth quarter of 2019. In connection with the restructuring, the Company expects to lose an immaterial amount of unpaid and past due interest under the terms of the loan.

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 and nine months ended September 30, 2019 and 2018:

For the three months ended 

For the nine months ended 

September 30, 

September 30, 

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

    

2019

    

2018

    

2019

    

2018

 

Provision (benefit) for loan losses

$

58

$

4

$

706

$

69

Provision (benefit) for risk-sharing obligations

 

(830)

 

515

 

2,158

 

773

Provision (benefit) for credit losses

$

(772)

$

519

$

2,864

$

842

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. Generally, 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. The Company fully funds a small number of

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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, respectively, on loans held for investment during the period of time the loan is outstanding. Included in Net warehouse interest income for the three and nine months ended September 30, 2019 and 2018 are the following components:

For the three months ended 

For the nine months ended 

September 30, 

September 30, 

Components of Net Warehouse Interest Income (in thousands)

    

2019

    

2018

    

2019

    

2018

 

Warehouse interest income - loans held for sale

$

11,721

$

16,684

$

38,697

$

36,830

Warehouse interest expense - loans held for sale

 

(10,812)

 

(14,389)

 

(37,549)

 

(31,945)

Net warehouse interest income - loans held for sale

$

909

$

2,295

$

1,148

$

4,885

Warehouse interest income - loans held for investment

$

7,381

$

2,209

$

24,428

$

5,278

Warehouse interest expense - loans held for investment

 

(2,118)

 

(624)

 

(5,972)

 

(2,034)

Warehouse interest income - secured borrowings

888

960

2,696

960

Warehouse interest expense - secured borrowings

(888)

(960)

(2,696)

(960)

Net warehouse interest income - loans held for investment

$

5,263

$

1,585

$

18,456

$

3,244

Total net warehouse interest income

$

6,172

$

3,880

$

19,604

$

8,129

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 $0.4 million and $0.9 million during the three months ended September 30, 2019 and 2018, respectively, and $3.9 million and $6.7 million during the nine months ended September 30, 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 September 30, 2019 and 2018 and December 31, 2018 and 2017.

September 30, 

December 31,

(in thousands)

2019

    

2018

    

2018

    

2017

 

Cash and cash equivalents

$

65,641

$

165,062

$

90,058

$

191,218

Restricted cash

9,138

16,226

20,821

6,677

Pledged cash and cash equivalents (NOTE 10)

 

5,361

 

40,325

 

9,469

 

88,785

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

$

80,140

$

221,613

$

120,348

$

286,680

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Contracts with Customers—The majority of the Company’s revenues are derived from the following sources, all of which are not in the scope of 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 September 30, 2019 and December 31, 2018. The following table presents information about the Company’s contracts with customers for the three and nine months ended September 30, 2019 and 2018:

For the three months ended 

For the nine months ended 

September 30, 

September 30, 

Description (in thousands)

    

2019

    

2018

    

2019

    

2018

 

Statement of income line item

Certain loan origination fees

$

18,754

$

15,981

$

45,665

$

39,637

Gains from mortgage banking activities

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

 

15,022

 

11,927

 

35,429

 

24,345

Other revenues

Total revenues derived from contracts with customers

$

33,776

$

27,908

$

81,094

$

63,982

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 Pronouncements—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 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 will adopt ASU 2016-13 when the standard is required to be adopted, January 1, 2020. The Company is in the process of finalizing the impact the Standard will have on its financial statements. The Company expects its allowance for risk-sharing obligations to increase substantially upon adoption of ASU 2016-13. The Company is in final stages of (i) establishing accounting policies, (ii) validating data, (iii) updating its processes, (iv) validating forecasts, and (v) implementing internal controls over financial reporting and expects to run parallel processing during the fourth quarter 2019.

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.

Immaterial Correction of an Error—In the fourth quarter of 2018, the Company identified and corrected an immaterial error in the calculation of earnings per share for quarterly and annual financial results presented in its previous filings. The Company’s 2018 Form 10-

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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 and basic and diluted weighted average shares outstanding for the three and nine months ended September 30, 2019.

Reclassifications—The 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 and nine months ended September 30, 2019 and 2018:

For the three months ended

For the nine months ended 

September 30, 

September 30, 

Components of Gains from Mortgage Banking Activities (in thousands)

2019

    

2018

2019

    

2018

Contractual loan origination related fees, gross

$

70,876

$

64,197

$

202,497

$

180,655

Co-broker fees

(5,732)

(4,603)

(13,947)

(17,052)

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

55,172

42,811

145,847

129,764

Fair value of expected guaranty obligation recognized at commitment

 

(4,387)

 

(3,235)

 

(12,852)

 

(10,451)

Total gains from mortgage banking activities

$

115,929

$

99,170

$

321,545

$

282,916

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 September 30, 2019 and December 31, 2018 were $884.4 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 September 30, 2019 is a decrease in the fair value of $27.5 million.

The impact of a 200-basis point increase in the discount rate at September 30, 2019 is a decrease in the fair value of $53.0 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 for individual assets.

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Activity related to capitalized MSRs for the three and nine months ended September 30, 2019 and 2018 is shown in the table below:

For the three months ended

For the nine months ended

 

September 30, 

September 30, 

 

Roll Forward of MSRs (in thousands)

    

2019

    

2018

    

2019

    

2018

 

Beginning balance

$

688,027

$

638,914

$

670,146

$

634,756

Additions, following the sale of loan

 

48,198

 

46,107

 

143,995

 

119,588

Purchases

1,814

Amortization

 

(34,531)

 

(33,157)

 

(103,001)

 

(98,119)

Pre-payments and write-offs

 

(4,344)

 

(4,676)

 

(13,790)

 

(10,851)

Ending balance

$

697,350

$

647,188

$

697,350

$

647,188

The following table summarizes the gross value, accumulated amortization, and net carrying value of the Company’s MSRs as of September 30, 2019 and December 31, 2018:

Components of MSRs (in thousands)

September 30, 2019

December 31, 2018

Gross Value

$

1,168,058

$

1,100,439

Accumulated amortization

 

(470,708)

 

(430,293)

Net carrying value

$

697,350

$

670,146

The expected amortization of MSRs recorded as of September 30, 2019 is shown in the table below. Actual amortization may vary from these estimates.

  

Expected

(in thousands)

  Amortization  

Three Months Ending December 31, 

2019

$

33,863

Year Ending December 31, 

2020

$

127,477

2021

 

114,030

2022

 

98,590

2023

 

86,425

2024

 

72,868

Thereafter

164,097

Total

$

697,350

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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. Activity related to the guaranty obligation for the three and nine months ended September 30, 2019 and 2018 is presented in the following table:

For the three months ended

For the nine months ended

 

September 30, 

September 30, 

 

Roll Forward of Guaranty Obligation (in thousands)

    

2019

    

2018

    

2019

    

2018

 

Beginning balance

$

51,414

$

42,470

$

46,870

$

41,187

Additions, following the sale of loan

 

3,729

 

4,078

 

13,323

 

9,147

Amortization

 

(2,365)

 

(2,057)

 

(7,061)

 

(5,814)

Other

(122)

(78)

(476)

(107)

Ending balance

$

52,656

$

44,413

$

52,656

$

44,413

Activity related to the allowance for risk-sharing obligations for the three and nine months ended September 30, 2019 and 2018 is shown in the following table:

For the three months ended

For the nine months ended

 

September 30, 

September 30, 

 

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

    

2019

    

2018

    

2019

    

2018

 

Beginning balance

$

7,964

$

4,070

$

4,622

$

3,783

Provision (benefit) for risk-sharing obligations

 

(830)

 

515

 

2,158

 

773

Write-offs

 

 

 

 

Other

122

78

476

107

Ending balance

$

7,256

$

4,663

$

7,256

$

4,663

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 September 30, 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 September 30, 2019. As of September 30, 2019, the maximum quantifiable contingent liability associated with the Company’s guarantees under the Fannie Mae DUS agreement was $7.4 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 $91.8 billion as of September 30, 2019 compared to $85.7 billion as of December 31, 2018.

As of September 30, 2019 and December 31, 2018, custodial escrow accounts relating to loans serviced by the Company totaled $2.5 billion and $2.3 billion, respectively. These amounts are not included in the accompanying Condensed Consolidated Balance Sheets as such amounts are not Company assets. Certain cash deposits associated with the escrow accounts at other financial institutions exceed the

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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 September 30, 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 $3.4 billion with certain national banks and a $1.5 billion uncommitted facility with Fannie Mae (collectively, the “Agency Warehouse Facilities”). The Company 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 $0.5 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 following table provides additional detail about the warehouse lines of credit at September 30, 2019.

September 30, 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

$

85,730

 

30-day LIBOR plus 1.15%

Agency Warehouse Facility #2

 

500,000

 

300,000

 

800,000

 

124,414

 

30-day LIBOR plus 1.15%

Agency Warehouse Facility #3

 

500,000

 

265,000

 

765,000

 

127,224

 

30-day LIBOR plus 1.15%

Agency Warehouse Facility #4

350,000

350,000

130,598

30-day LIBOR plus 1.15%

Agency Warehouse Facility #5

500,000

500,000

206,141

30-day LIBOR plus 1.15%

Agency Warehouse Facility #6

250,000

100,000