Walker & Dunlop, Inc. CEO Discusses Q1 2013 Results - Earnings Call Transcript

May. 8.13 | About: Walker & (WD)

Walker & Dunlop, Inc. (NYSE:WD)

Q1 2013 Earnings Call

May 07, 2013 8:30 a.m. ET

Executives

Claire Harvey – Vice President-Investor Relations

Willy Walker – President and Chief Executive Officer

Stephen P. Theobald – Chief Financial Officer, Treasurer and Executive Vice President

Analysts

Ryan O'Steen - Keefe, Bruyette & Woods

William Marks - JMP Securities

Jason Stewart – Compass Point

Brandon Dobell - William Blair & Company

Cheryl Pate - Morgan Stanley

Operator

Welcome to Walker & Dunlop's First Quarter 2013 Earnings Conference Call and Webcast. Hosting the call today from Walker & Dunlop is Willy Walker, Chairman and CFO. He is joined by Steve Theobald, Chief Financial Officer, and Claire Harvey, Vice President of Investor Relations.

Today's call is being recorded and will be available for replay beginning at 11 a.m. Eastern Standard Time. The dial-in number for the replay is 800-839-1180. At this time all participants have been placed in a listen-only mode and the floor will be open for your questions following the presentation. (Operator Instructions).

It is now my pleasure to turn the floor over to Claire Harvey. Please go ahead.

Claire Harvey

Thanks Jack. Good morning, everyone, and thank you for joining the Walker & Dunlop's first quarter 2013 earnings call. Joining me this morning are Willy Walker, our Chairman, President and Chief Executive Officer; and Steve Theobald, our Executive Vice President, Chief Financial Officer and Treasurer.

This call is being webcast live on our website and a recording will be available later this morning. Both our earnings press release and website provide details on accessing the archived call. This morning we posted our earnings release and presentation to the Investor Relations section of our website, www.walkerdunlop.com. These slides serve as a reference for much of which Willy and especially Steve will be touching on this morning. So participants who are interested in following along should pull those up and have them available.

Please also note that we may reference certain non-GAAP financial metrics such as adjusted net income, adjusted earnings per diluted share, adjusted operating margins, adjusted income from operations and adjusted total expenses during the course of this call. Please refer to the earnings release and presentation posted on our website for reconciliations of the GAAP and non-GAAP financial metrics and related explanations.

Investors are urged to carefully read the forward-looking statement language in our earnings release. Statements made on this call which are not historical facts may be deemed forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements, including statements regarding future financial operating results, involve risks, uncertainties, and contingencies, many of which are beyond the control of Walker & Dunlop and which may cause actual results to differ materially from the anticipated results.

Walker & Dunlop is under no obligation to update or alter our forward-looking statements, whether as a result of new information, future events, or otherwise. We expressly disclaim any obligation to do so. More detailed information about risk factors can be found in our reports on file with SEC. Willy?

Willy Walker

Thank you, Claire, and good morning and thank you for joining us. This is our first call with Steve Theobald the CFO of Walker & Dunlop and I have very pleased to have Steve sitting next to me this morning. Steve arrived at Walker & Dunlop on April 1st and has made a quick and very smooth transition to his job as Chief Financial Officer. I will outline a number of the quarter's accomplishment's, touch on the regulatory environment, turn the call over to Steve to explain our financial performance in more detail and then I will finish the call by providing insight into the coming quarters and the rest of 2013 from a strategic growth standpoint.

Walker & Dunlop closed the acquisition of CWCapital in September 2012 and rolled into the fourth quarter with robust pipelines and huge challenge of flawlessly processing more business than we had ever seen. After meeting that challenge we entered 2013 with time to focus on outstanding integration issues and driving Walker & Dunlop and CWCapital together. I am pleased to report that we made significant progress on the outstanding integration items and have relatively minor issues still to address. That does not mean we are done. Integrating two great firms such as Walker & Dunlop and CW takes time and consistent effort to ensure we get it right.

We have lost very few people since acquiring CW due to exhaustive work to ensure compensation, responsibilities, workflows and our culture are properly aligned for all employees. That is no small feat particularly given the highly competitive landscape for human capital in our industry.

We participated in many conferences during the first quarter and saw firsthand market participants' reaction to Walker & Dunlop's new scale and standing within our industry. Several clients that either CW or Walker & Dunlop have targeted for years were for the first time interested in working with us due to our new scale, breadth of services and expertise. Although we are still young as a merged organization the internal and external feedback to this combination is very exciting.

As we announced at the beginning of April, Q1 origination volume was $1.73 billion and reflects very strong year-on-year growth. Loan originations of Freddie Mac were up 509% from Q1, 2012 to 515 million, a fantastic start to our year with Freddie. Volumes of Fannie Mae were up a 185% from Q1, 2012 to $763 million, a solid start to the year with our largest lending partner.

Our expectation when bringing Walker & Dunlop and CW together was that one plus one would equal more than two. We originated $1.28 billion of loans with Fannie Mae and Freddie Mac in Q1, increasing combined Walker & Dunlop and CWCapital originations by 48% from the first quarter of 2012, a clear demonstration of the power of this combination and our ability to continue gaining market share.

As we mentioned in our April 8 press release the Department of Housing and Urban Development reduced their loan commitments dramatically during the month of March due to delay in the passage of the federal government's continuing budget resolution. This reduction in commitment volume impacted our ability to raise, lock and close HUD loans, bringing our quarterly volume to $147 million, up 31% over 2012. HUD began issuing commitments again after the passage of the continuing resolution and is essentially business as usual for now.

However HUD recently announced a significant reorganization and office rationalization, which may cause uncertainly within the agency over the coming months. We believe the changes implemented by HUD will be very positive in the long term, although we will miss many of the expert HUD staff that will be electing to take early retirement during this process. As well there is no guarantee that the funding providing provided by the passage of the continuing resolution will be sufficient to satisfy HUD's funding needs through the remainder of the year given borrower demand for HUD's long term fixed rate products. Our HUD pipeline is strong and we are confident in our team's ability to navigate the HUD process and political overlay to meet our annual origination target.

We made significant investments in our Capital Market's origination platform last year by adding teams in Florida and Wisconsin. Our Capital Market's origination volume of $306 million was up 46% over 2012, which is stronger than the 9% industry growth in the first quarter. We have excellent originators with fantastic client relationships and it's our belief that our Capital Market's volumes continues to grow throughout the year as life companies, CMBS, banks and the agencies all try their to meet their annual .origination goals.

First quarter originations of $1.73 billion produced revenue of $69.2 million, up 101% over Q1, 2012. Adjusted operating margin of 20% is in line with previous first quarters on a normalized basis due to the relatively lower origination volumes in Q1. We have the people and infrastructure to originate between $2 billion and $3 billion in loans per quarter and we expect to on that pace in Q2 to achieve our annual origination guidance of $10 billion to $12 billion. As quarterly origination volumes has move up to the $2 billion to $3 billion range, our operating margin will expand in the high 20s and low 30s.

Net income for the quarter was $7.7 million or $0.23 per share, up from $5.8 million or $0.27 per share in Q1, 2012. Steve will dive into the numbers in greater detail when I turn the call over to him. But I would simply say that growing originations over a 100% year-over-year, integrating two companies almost flawlessly and producing the most profitable quarter in the company's 75 years history is quite an accomplishment.

I would like to turn to the regulatory environment for a moment. In early March the Federal Housing Finance Agency, FHFA came out with their 2013 score card for Fannie Mae and Freddie Mac, calling for reduction of GSE's 2013 multi-family origination by 10% to "bring additional private capital" to the market. Many in the industry were surprised by FHFA's actions due to significant amount of private capital already in the overall multi-family financing market and specifically within Fannie and Freddie's multi-family businesses. We have met with Fannie, Freddie legislators and FHFA over the past month to better understand the implications of this action.

First, for all practical purposes it is business as usual at Fannie and Freddie, with $30 billion of capital from Fannie and $26 billion from Freddie the two GSEs will be by a wide margin the largest providers of capital to the multi-family sector in 2013. To put their combined $56 billion of capital into perspective, a total of $103 billion was lent on multi-family properties in 2012. So if $100 billion is lent on multi-family properties in 2013 Fannie and Freddie will have a 56% market share and will still be the dominant providers of capital to the multi-family sector. Walker & Dunlop will continue to be one of the largest partners to Fannie and Freddie and continue growing our market share as demonstrated by our Q1 origination growth of 48% with Fannie and Freddie.

Let's focus for a moment on the broader issue of GSE reform in Capitol Hill. What is most dramatic about the GSE debate on Capitol Hill is that the discussion has evolved from how we wind down Fannie and Freddie to how we reform Fannie and Freddie before they simply become cash cows of the U.S. Treasury. Freddie Mac made $11 billion in 2012 and Fannie Mae made $17 billion. To put those numbers in context, the sequester is cutting $85 billion in government spending in 2012. Fannie and Freddie's 2012 earnings are 33% of that number. We are hard pressed to see this Congress pass legislation that would cut a revenue source that can replace over one-third of the sequester cuts in the federal budget.

So the debate over the future of Fannie and Freddie appears to be moving from one about housing policy to one about fiscal policy. Senator Mark Warner of Virginia and Senator Bob Corker of Tennessee are working on the first bipartisan GSE reform legislation, that would require private capital to share risks in both the single family and multi-family businesses, keep Fannie and Freddie as part of the federal government and maintain Fannie and Freddie's multi family businesses much as they are today. Whether this bill or some other bill ends becoming law, what is clear is that the debate over the future of Fannie and Freddie has shifted dramatically as the economy is recovered, the billions that tax payers invested in the GSE's starts getting paid back and the concerns over two big to fail banks makes an alternative to the GSEs harder to implement.

I would like to the turn call over to Steve, so he can discuss our Q1 financial performance in further detail. I will then finish the call discussing our progress on creating new proprietary capital solutions and what we see ahead of us for the remainder of the year. Steve?

Stephen P. Theobald

Thank you, Willy and good morning everyone. I couldn't be more excited to be part of the Walker & Dunlop team. My first month has just flown by, and I appreciate that I have not yet a chance to interact with most of you on the phone. I look forward to that chance and the opportunity to meet with you face to face in the near future. Willy mentioned that I will be covering some of the details behind our financial results for the quarter. As a back-up to that discussion and as I will explain in greater detail, our results were consistent with our typical first quarter pattern.

Net income for the first quarter was $7.7 million or $0.23 per share. Adjusted net income which excludes selected expenses relating to the acquisition of CWCapital was $8.5 million or $0.25 per share. Operating margin for the quarter was 18% and adjusted operating margin was 20%. This compares to net income of $5.8 million or $0.27 per share and operating margin of 28% in the first quarter of 2012.

As we disclosed several weeks ago we originated $1.73 billion in loans during the quarter, 157% more than the total originated during the same period last year, a solid number especially by first quarter standards. Gains on mortgage banking totaled 42.9 million or 248 basis points on that 1.73 billion of volume. This is slightly below our annual average of 262 basis points as the lower percentage of HUD volumes during the quarter resulted in a shift of our mix of loans toward relatively lower margin business.

In addition, during the quarter we locked one large Fannie loan that represented nearly 10% of our first quarter volume. This one has a shorter expected life than our average Fannie Mae loan which resulted in a lower than average margin for the related mortgage servicing right. As discussed in the past it is not unusual for us to get looks at large deals like this one. But the timing of when they happen is unpredictable and when they happen in our traditionally lower volume quarters the impact on some of our profitability metrics can be significant. We continue to see healthy origination fees across all business lines and believe our gain on sale margin will be in line with our historical average over the course of 2013.

Servicing fees were $21.1 million for the quarter compared to $9.4 million in the first quarter of 2012. Our servicing portfolio continues to grow increasing to $36.8 billion from $35.3 billion at the end of 2012. The average servicing fee remained at 24 basis points. Servicing was one of the most complex parts of the integration with CW and I am pleased to say that the team has done a great job and is nearly through with its integration work.

Turning to expenses, total expenses during the quarter were 56.9 million, an increase of 128% from the first quarter of 2012. The increase in total expenses when compared to the year ago quarter was driven primarily by higher personnel cost and an increase in amortization and depreciation, both of which I will discuss next.

Personnel expense was $28.3 million, up from $11.6 million in the first quarter of 2012 as our employee base more than doubled from a year ago, including a 136% increase in the number of producers on our team. Personnel cost as a percentage of revenues were 41%, in line with our expectations. We are a substantially larger company than we were a year ago and we have the capacity to handle the significant increase in origination volumes we expect in 2013.

Amortization and depreciation expense totaled $18.6 million in the quarter, up from $7.3 million in the first quarter of 2012. The increase in amortization and depreciation is no surprise after 118% growth in the servicing portfolio. In addition, $2.7 million of the amortization expense was related to the write-off of MSRs due to the prepayment of the underlying loans. And of that $2.7 million, $2.3 million was related to prepayments of HUD loans.

As we have discussed in the past the underlying HUD loans do contain prepayment penalties but unlike agency loans when a HUD loan is prepaid none of the prepayment penalty comes to Walker & Dunlop. Also included in total amortization and depreciation expense is $1.3 million for the amortization of the intangible pipeline asset acquired in the CW transaction. The remaining intangible assets at the end of the quarter were $2.2 million which we expect will be expensed over the remainder of 2013.

On the credit front we provided 401,000 to increase our allowance for risk sharing obligations, compared to 1.2 million in the first quarter of 2012. It is important to note that at the end of the first quarter we had no 60 plus days delinquencies in our at-risk portfolio. We continue to be very pleased with our credit performance and continued low levels of defaults and losses.

During the quarter we produced an adjusted operating margin of 20%, lower than our annual target but consistent with our typical first quarter performance when the prior quarters are normalized with significant one-off benefits. For example, during the first quarter of 2012 we recognized $2.5 million of other income related to the amendment of a fee arrangement between the company and a correspondent. Removing this one-off benefit from the prior year's results reduces the operating margin in that quarter from 28% to 22% comparable to this year's 20%.

Similar positive benefits occurred in the first quarter of 2011 as well. The point of all this is that except for the fact that we have more than doubled in size the results of our core business in the first quarter of 2013 do not look much different than first quarters in the past, as we typically enter the year with capacity to achieve our annual volume goals, knowing that first quarter's typically our lightest volume quarter and operating margin will reflect that pattern.

Before I turn the call back over to Willy I want to mention a few items related to the second quarter. First we have been able to negotiate pricing reductions of 20 and 25 basis points on our two primary warehouse lines, which will begin to benefit us immediately in the second quarter as volumes pick up. We also recently realized or finalized a restructuring I believe for our Needham, Massachusetts office, which we had anticipated as potential future expense when we closed the CW transaction. The results of the restructuring will be an $800,000 expense in the second quarter.

As Willy will discuss in a moment we have also made great progress in our proprietary capital initiatives. As we previously told you we expect to incur $5 million to $15 million of expenses related to these initiatives. And we incurred very little of that expense in the first quarter.

Finally we expect second quarter volumes to increase from the first quarter and are establishing loan origination guidance for the second quarter of $2.3 billion to $3 billion. As I reflect back in my first months at Walker & Dunlop I have been most impressed with the caliber of the people I have met and their passion for this company.

As an anecdote a couple of weeks ago I was fortunate enough to participate with about 40 of my co-workers in the American Odyssey Relay Race from Gettysburg to Washington DC. The relay is a 200 mile race with team of 12 alternate running 36 legs of varying miles and terrain over the course of about 24 hours. Participating in this event gave me first hand insight into the spirit of the Walker & Dunlop team. Not just their competitiveness and drive to win, but the mutual respect and support they share for each other. And this spirit went beyond just the participants and volunteers but extended to the entire company, as we raised over $12,000 for the victims of the Boston Marathon bombing through the generosity of the entire Walker & Dunlop employee base.

I am proud to be a part of this company and look forward to many more months ahead. With that I will turn it back over to Willy.

Willy Walker

Thank you Steve and I would reiterate what a pleasure it is to have you on our team. I would now like to discuss the significant progress we made during Q1 to raise capital for Walker & Dunlop's proprietary Capital Group. As we have discussed before Walker & Dunlop's loan origination underwriting and asset management businesses are scaled, efficient and excellently run. Walker & Dunlop is a very significant partner for the three major sources of capital for multi-family which rely on our expertise to deploy their capital.

There are multi-family loans which do not fit Fannie Mae, Freddie Mac and HUD's programs such as interim loans and higher leverage loans. As well Walker & Dunlop's expertise in the multi-family market can and should be used to lend on other commercial property types such as office buildings, retail centers and hotels. Our proprietary Capital Group is focused on raising capital so that Walker & Dunlop can expand its market reach in multi-family and also grow as a lender into other asset classes.

Each initiative builds a scalable platform with the people and capital to grow dramatically over the coming years. You will note that each initiative is focused on distinct forms of capital to meet our client's needs and investor's return expectations. The first initiative is a bridge loan program that will invest in multi-family and senior housing loans of $30 million or more. Walker & Dunlop is in final negotiations with the foreign pension funds and large U.S. real estate investment firm to commit a combined $380 million into a limited partnership where Walker & Dunlop will serve as general partner and co-invest $20 million bringing the total anticipated equity commitments to $400 million.

Many of the properties are likely to be high profile assets due to the target loan size of the program and some loans will be backed by portfolios of properties rather than single assets for the same reason. Typical transactions will likely be acquisitions where a borrower is looking to rehabilitate or reposition an asset and needs bridge financing. We expect to have this program in full operation before the end of Q2.

The second initiative is the establishment of a CMBS loan origination platform. The commercial mortgage backed securities industry is coming back strong with originations of over 50 billion in 2012 and expectations of 60 billion to 70 billion in 2013. As investors know the CMBS industry has waxed and waned over the years. Surging origination volumes in the mid-1990s collapsed around the long term capital management crisis in 1998 and then surged again in the mid-2000s only to have the 2008 financial crisis literary decimate the industry. It is with this historic perspective in mind that Walker & Dunlop enters this arena with very specific designs and risk tolerance. We are in final negotiations with a leading global private equity firm to form a joint venture for the origination of multi-family and commercial mortgage loans, intended for securitization through several Wall Street firms.

Walker & Dunlop will set up a separate subsidiary to serve as a minority partner in the venture which will aggregate loans for a very limited period of time prior to securitization, Walker & Dunlop plans to invest somewhere between $15 million and $20 million of capital in this venture. We have hired Tim Kolterman to lead our CMBS origination platform, Mr. Kolterman is a 25 year industry veteran who previously ran a new issue capital market CMBS business at Bear Stearns and has a fantastic reputation in the mortgage securitization market. Tim is currently working to assemble the rest of his team.

With a deeply capitalized venture partner, a strong team of professionals under Tim's leadership and access to deal flow through our proprietary sales force we believe this venture has a great opportunity ahead of it. The business plan for CMBS platform is to execute one securitization per quarter, meaning upwards of $650 million per year of loan sales. The interim loan program is initially being capitalized with $400 million of equity and with approximately 65% leverage will have $1.2 billion in initial lending capacity. We are also continuing to explore commercial mortgage REIT strategy with our advisors and are also focused on raising a separate account to provide long term fixed rate capital to our borrowers.

Life insurance companies originated $10 billion of whole loans on multi-family properties in 2012 and are a strong competitive bid to the agencies so far this year. With Walker & Dunlop's access to deal flow underwriting and servicing platform and extremely strong credit track record, we believe there is long term pension fund and life insurance company capital that would invest in such a vehicle managed by Walker & Dunlop. Why is all this activity so exciting? First, we've stated since going public that we would diversify our sources of capital. These initiatives do just that.

Second is the commercial real estate markets continue to recover and clients needs evolve from simply a first trust mortgage to acquisition financing or a first trust loan at a higher leverage point or longer maturity. Walker & Dunlop will have the appropriate capital to meet those needs. And finally by having these capital solutions managed by Walker & Dunlop we believe we will be able to control more deal flow.

If a long standing Walker & Dunlop borrower wants to know the cost and dynamics of a CMBS loan, an agency loan or a long term fixed rate life insurance company loan, Walker & Dunlop will have the ability underwrite, structure, price and execute on all of these alternatives with our own capital or with third party capital through our capital markets business. This broadening of our business model will capture more deal flow and maintain strong operating margin as a lender and asset manager. I am extremely pleased with the progress we've achieved along these lines during Q1 and very excited about the potential of this business model.

In closing I reiterate several of the messages Steve and I have made this morning. First quarter was a solid quarter for our company growing origination volumes and revenues by over 100% year-over-year, and dramatically faster than the industry at large. We've effectively brought together two fantastic companies without skipping a beat and delivered operating margins that are in line with previous first quarters on a normalized basis. We did this while meeting our clients' demands and maintaining the culture that made CW and Walker & Dunlop such great firms. And we made great progress on building proprietary capital solution that will allow us meet our clients' financing needs with capital we control that benefits from the scaled origination, underwriting and servicing platform Walker & Dunlop has successfully built.

I continue to be extremely impressed and proud of the fantastic work that everyone at Walker & Dunlop does every day. With that I want to thank all of you for joining us this morning, and I will now turn the call over to the operator for any questions.

Question-and-Answer Session

Operator

(Operator Instructions). And our first question comes from Bose George with KBW. Please go ahead.

Ryan O'Steen - Keefe, Bruyette & Woods

Hi, good morning. Actually this is Ryan O'Steen on for Bose. First just a couple of questions on HUD. I missed some of your earlier comments, but I think you noted the reorganization can cause some uncertainty. Could you just expand on this? I mean do you see a material risk of loss of HUD volume. And just in regards to your 2013 guidance, do you assume any material loss of volume or does that guidance just kind of assumes business as usual at HUD?

Willy Walker

Yeah, Ryan, good morning. First of all we reiterated our annual guidance September '12 so there is no adjustment to that whatsoever. As it relates to HUD, HUD today has 17 what they call hub offices across the country and then they have 50 satellite offices that feed loans into those hub offices. So they've got 67 offices across the country and they have announced a reduction from 67 to 10. So they will have five hub offices and five satellite offices of those hubs.

That planned rationalization is taking place over the next three years and everybody at HUD is being offered a job in one of those, either satellite or hub offices. But with the rationalization from 67 to 10 as you can imagine there are plenty of people who may not want to move from let's just Nashville, Tennessee to Jacksonville, Florida where Jacksonville will be one of the regional hub offices.

So there is a significant expectation that there will be a number of people at HUD who will take early retirement. And so we are putting that out there as there are moving parts inside of HUD today and does that end up delaying loan processing. We certainly hope not but there is no doubt that an announcement of that hype of a restructuring has got people inside of HUD talking and thinking about what their future is going to be. We are very focused on processing as much businesses we possibly we can and given our present scale and the size of our HUD operation we are very focused on navigating through both the internal and external issues related to HUD financing today.

Ryan O'Steen - Keefe, Bruyette & Woods

Okay, great. Switching just to the expense side, the margin in came a little weaker than we were expecting. I know there is some seasonal factors there but it sounds like you are still planning to get that backup into the low 30s. Could you just kind of walk through what were the higher expenses this quarter and how you plan to gain back some margin?

Willy Walker

So if you look at Q1 originations of 1.7 billion, as we have shown that was a fantastic growth year-on-year and we also gave you in there our growth in our Fannie and Freddie business in combination with what CW did in Q1 of last year, growing that number 48% year-on-year which is stronger than the agencies and stronger than many of our competitors. The issue is that Q1 as Steve said is always a relatively low quarter as it relates to overall aggregate origination volume. So as we move into the $2 billion to $3 billion a quarter origination level we will gain economies of scale, the underwriters in Q1 that were busy but not running around the clock will be busy in running around the clock again and you will gain economies of scale in our platform and you will move margins back-up as you get to those high origination volume numbers.

I would also say that one of the other areas that I believe there was, if you will some, I don't want to say confusion, but when we announced our Q1 origination volume of 1.73 billion we put out there the breakout between Fannie, Freddie, HUD and capital markets and if you run what most people's models say on our average servicing fee for those four executions I would believe that most analysts would have come out with a lower MSR number. And so I think that one of the things you will see is we did so much Freddie in the first quarter as Fannie and HUD do greater percentages of the volume in Q2, Q3, Q4 you are booking larger MSRs and that obviously produces higher revenues and that obviously then allows us to get expanding margins.

Ryan O'Steen - Keefe, Bruyette & Woods

Thanks and one more if I could. You mentioned the large loan Fannie Mae loan that was lost in 1Q and the impact on…

Stephen P. Theobald

It wasn't lost, it was locked in Q1.

Ryan O'Steen - Keefe, Bruyette & Woods

I am sorry locked in Q1.

Stephen P. Theobald

So it was a larger loan Ryan, that was locked in Q1 so when you have a $150 million plus loan where we are taking limited loss sharing on that loan and this loan happened to have a shorter term, it wasn't a ten-year loan. You are just on 150 plus million dollars of aggregate origination volume where it is a large loan where we were taking limited loss sharing so our servicing fee is smaller and then it's on a shorter duration. So you are using a shorter average life. You are going to book an MSR that is not in line with what $150 million of $10 million Fannie loans would have computed too, if you had 15 $10 million deals versus one $150 million deal. Does that make sense?

Ryan O'Steen - Keefe, Bruyette & Woods

Yeah, that does. Thanks for the clarification there. I will jump off thank you.

Operator

And we will go next to William Marks with JMP Securities. Please go ahead.

William Marks - JMP Securities

Thank you and good morning everyone.

Willy Walker

Good morning

William Marks - JMP Securities

I guess I first want to ask you had mentioned that the operating margins that about first quarter being near the normal first quarter. Is there a normal for second, third, fourth and just -- it's so hard for us to get a sense of margins. We can get the revenues right, not really always too, but is there any good way to look at it?

Willy Walker

I think Will, as you well know because you covered us so closely since becoming a public company, a lot of it depends on origination volumes, and as you have seen in our history Q1 is our lightest volume quarter. Two and four are the strongest and three sort of sits somewhere in between. And then inside of that it really depends as it relates to margin on what the mix is. So you have seen some margin like Q2 last year where we had significant origination volume of Fannie loans in Q2 of last year and I think I am correct I don't have it in front of me but I think we had a greater than 40% operating margin. I think we had like 41% operating margin in Q2 of last year.

I've got -- Claire is looking up but right now I don't misspeak on that but I believe that Q2 is a very strong quarter because we had so much Fannie and we also had a very strong HUD quarter. And so it really does I mean as we try to explain to investors we are looking at this business on annual basis not on a quarterly basis. We obviously report on a quarterly basis, but as you have seen over the years we both get our volume numbers as well as our margin expectations but those are going to vary quarter-by-quarter. And so we just keep our head down and move through it. I've got -- I just gotten, yeah Q2 '11, 43% was the operating margin in Q2 of '11 and Q2 '12 was 32%.

So you can see just in those two quarters a pretty significant variance and again that back to aggregate origination volumes and then also the mix of how much is Fannie and how much is Freddie how much is HUD and how much is capital markets.

William Marks - JMP Securities

All right, thank you. Another unrelated question to that is on this 2012 I think we call this conservative score card, I was reading about representative (Watt) taking over I am curious I don't if this is something for a conference call necessarily but your view on the change in leadership and how that impacts origination volumes by the GSEs?

Willy Walker

So a lot of the discussion right now is focused on FHFA, given their 2013 score card, Acting Director DeMarco has been Acting Director I believe now for four, going on five years. And many people have been, if you were, waiting for his replacement for quite some time. The fact that the President has nominated Representative Watt is not surprising because people were waiting for a nomination. As you may have seen Will representative Watt's nomination was met with some significant opposition on the Republican side of both the House and the Senate and there are plenty of questions as it that relates to whether Representative Watt will get through the confirmation process.

I do believe that there is an editorial in today's New York Times focused on the nomination of Watt. I didn't have time to read it but I saw the headlines this morning. So I think you will likely see a new Director at FHFA in 2013, and I do believe that the administration will put their shoulder behind Representative Watt's nomination. Whether he gets through the confirmation process or not I think is the question and then how all that plays in to what FHFA does in 2014 and beyond, I think a lot depends on who is the Director of FHFA and how they look upon what FHFA has done in the past both this year and last year as it relates to the score card, and where they believe FHFA's role ought to be vis-à-vis the legislative reform process that's taking place upon Capitol Hill.

I think that FHFA stepped forward this year because they saw very little happening on Capitol Hill. It has been very evident that since FHFA stepped forward and put forth their score card that there has been a tremendous amount of activity on Capitol Hill to if you will pull the regulation or the reform of Fannie and Freddie back from that FHFA and onto the Hill and onto a legislative debate.

William Marks – JMP Securities

Okay thanks for the color on that and I guess that's it from me for now. Thanks.

Willy Walker

Thanks Will, thanks.

Operator

And we'll go next to Jason Stewart with Compass Point. Please go ahead.

Jason Stewart – Compass Point

Good morning, thanks. Steve, welcome back to the specialty finance world.

Stephen P. Theobald

Thanks Jason. I appreciate it.

Jason Stewart – Compass Point

And Willy along the same lines as the last question I mean one of the things we have seen around the FHFA recently is this viability of the multi-family business release and I was curious to know if you had any further comments on the way that the FHFA has affectively I guess concluded what this is worth to them and any impacts on Fannie and Freddie and HUD going forward from it?

Willy Walker

So Jason if you -- there was nothing really surprising in the white papers as it relates to the value of Fannie and Freddie's multi-family businesses both inside and if you will in a spin-off model with or without a guarantee, numbers that actually I think that we've talked about before. I think the message that has come out of it is that the multi-family businesses would have loved to be spun-off from the agencies. I think that's not a path that's going to happen any time soon and if the value of them without a guarantee is significantly less than with the guarantee, I don't think anybody is surprised by that.

I think the bigger story here is that people are understanding both the fact that the multi-family businesses performed extremely well during the downturn. You may have seen the hearing that Director DeMarco had up with the Senate Banking Committee where Senator Mark Warner asked him significantly about the multi-family business and about that it wasn't a problem and its performance was fantastic throughout the downturn and that was actually followed by a question by Senator Shelby asking about the risk sharing model in the multi-family business and whether it might be a good move to put risk sharing on the single family side.

And so I think that there is lot of focus on multi-family model right now and I think that the white paper's release makes people realize that Fannie and Freddie through their multi-family businesses provide capital to sectors of the multi-family market that private capital probably wouldn't provide capital to and so I think that, that underscores the importance of Fannie and Freddie's multi-family businesses and that if they were spun off in the private enterprises they would probably focus on the exact same assets and the exact same borrowers that life insurance companies and CMBS focus on which would mean that capital will not be broadly distributed across the country to all asset classes and to all geographies.

Jason Stewart – Compass Point

Okay so if we think about that so what it means to you, I mean effectively this scorecard and this white paper are sort of at odds, is that true?

Willy Walker

Well if you are saying that the white paper says Fannie and Freddie's multi-family business is really important and then you have got FHFA pulling them back by 10%, yeah you could say that they are at odds. You could also say that with $56 billion of capital, 10% reduction or from $61 billion back to $56 billion really isn't a major move.

When I met with FHFA two weeks ago they sort of said what are you sort of complaining about, this is nothing. And my comment to them was well this came out of left field and as a publicly trading company, investors don't like surprises. And so if you guys have a roadmap for where you want to go in the future it would be very nice if you share it with the industry so that we could message these type of things to our investors so that they don't wake up one day like we did and find out you have decided you are going to take 10% of multi-family.

They understood that. They agreed with the way that they acted wasn't helpful as far as guiding where things were going but I guess that's a long way of saying Jason, we don't know who will be the Director of the FHFA next year when the new scorecard comes out and if they were to go and take another 10% out of it that reduces Fannie and Freddie from 56 billion down to 50 billion. They are still going to be the dominant sources of capital for the multifamily industry and we continue to gain market share with them. And so even if they are a smaller portion of the industry we continue to grow there and then we are developing our own proprietary capital to be able to expand if and when they kick more of the agencies.

Jason Stewart – Compass Point

Okay I appreciate the color on that. And then on your last point, historically you talked about three avenues for growth and private capital at Walker & Dunlop. I think you mentioned two, I didn't hear a third. I apologize if I missed it but historically you talked about a mortgage REIT as an avenue and I know you spent a lot of time and it appears like you are making progress in the other two, did I miss the third or if you didn't mention could you give us some update on where you stand on the third.

Willy Walker

Yeah, I'll just read back to you quickly what I said, which is we are also continuing to explore commercial mortgage REIT strategy with our advisors and are also focused on raising a separate account to provide long term fixed rate capital to our borrowers. And I went on to talk about life insurance companies and the attractiveness of either a pension fund or life insurance companies investing in a separate account with Walker & Dunlop to provide that type of capital.

Jason Stewart – Compass Point

Okay and last one and then I'll jump out, the progression of costs associated with those avenues of private capital, could you just talk about, maybe Steve, it's a question for you, how that's impacted the income statement and may be perhaps going forward just broad numbers about where it's been reflected and where it could go?

Stephen P. Theobald

Jason, we've I guess prior to the beginning of the year we flagged that we are going to spend somewhere between $5 million and $15 million on the proprietary capital initiatives in 2013. Very little of that has been spent in the first quarter, but we still are providing that ranges, our current estimate of what we think the expense would be over the course of the rest of the year.

Jason Stewart – Compass Point

Yeah, thanks for the questions.

Operator

And we will next to Brandon Dobell with William Blair & Company. Please go ahead

Brandon Dobell - William Blair & Company

Thanks, good morning.

Willy Walker

Good morning.

Brandon Dobell - William Blair & Company

Just staying with the last question for a second, decent kind of range of what second or third quarter expenses related to these new capital sources could look like. Should we expect given your comments around bridge and CMBS platforms, should we expect a big chunk of that by the 15 show up in Q2 or do you think the Q3 is a better place to put it.

Stephen P. Theobald

Yeah Brandon I don't know that I would say big chunk, I think certainly I would expect that some of that expense will start to flow through our income statement in the second quarter but because of the fluid nature of our ongoing discussion around these initiatives it's hard to pinpoint exact number.

Brandon Dobell - William Blair & Company

Okay, and then may be kind of from a prospective point of view how should we expect to see kind of disclosures or reporting around these new source of capital you are going to show up on other line. I know there are some different structure that are going on here. So how should we think about building our either revenue or expense line to accomplish these initiatives?

Stephen P. Theobald

Yeah, I think the costs are going to -- will show up in multiple different lines in the GAAP income statement. I think it is our expectation that to the extent that those costs are material to the overall performance of the company we will provide some details on those.

Brandon Dobell - William Blair & Company

Okay, then switching may be to the comments made at the outset Willy about the market reception to your (inaudible) momentum, how do you think about that relative to increase in the producer headcount. Should we continue to expect you guys to be really active, somewhat active, didn't get the right team in place so it's kind of -- let's call headcount questions from a producer point of view?

Willy Walker

Yeah, Brandon if I look at and we as you know is constantly looking for good origination talent. I would put forth that as you well know some of our competitors hired a lot of people and didn't have origination if you will keep up with the amount of headcount and as a result sort of when they had origination volumes go down quarter-on-quarter, got hit with that if you will mismatch.

We, because of the CW acquisition we've grown our producer headcount dramatically and in the process of also doing that acquisition we've also locked in on long term employment contracts many of our origination talent which heavily de-risk the platform and makes it that we know that those people are around here originating loans for Walker & Dunlop for the coming years. And so all of those costs are running through there, and at the same time you can see the growth that we've had on a quarter-on-quarter basis as well as the growth we had with our two primarily lending partners where we are clearly gaining share.

We still need to add capital market execution in the Southwest and in the West, and so we are still out there looking to complete that that was something that we set up as a strategic initiative last year. We got through the Southeast and sort of the Midwest and we need to now get teams out on the west. So we are still very much looking there. And then as it relates to other production talent we always are looking for those people but right now what we are looking to do is we got a fantastic team on the field, if you will and we know that that team has the ability to originate the 10 billion to 12 billion that we have in annual guidance. And so really right now we are very focused on getting to that number.

We have the team on the field to get to that number so we don't need to hire additional people to get to it, and then running our platform as efficiently as possible to maintain the margins that we have put up in the past. And so that's really the focus right now with obviously as you know us we are constantly out there looking for strategic opportunities to hire new people and to grow the business.

Brandon Dobell – William Blair & Company

Okay. And then touching the points you made about the CMBS platform, what kind of timeframe should we expect for you guys to be holding those aggregated loans. Just want to make sure I understand kind of how to bracket the risk profile of…

Willy Walker

Great question. As I tried to emphasize in my comments Brandon we entered this space with a lot of excitement but also with plenty of, if you will, understanding of the risks in entering this space. So as I said in my comments this will be a joint venture where Walker & Dunlop has a minority interest. So we are not taking the majority equity position here. And the second thing is that you can't really hedge the risk in a CMBS platform. You can buy all sorts of instruments but when the market goes sideways on you, there are all of those hedges don't -- they go away. And so the only true way to hedge out the risk is to turn your book as quickly as possible.

And so one of the things that we are doing here is we are setting very specific parameters on how much volume we will pool. We will not exceed $200 million of pooling to begin with, in this venture and it is our expectation to do a securitization once a quarter. So that would mean that we will hold the $200 million for less than 90 days. So that's the business model at the outset and we are setting up to be pretty true to that sort of construct, because we had seen in the past people who start with really good parameters and then nail out the parameters to fade away a little bit as the market gets hot and they start making more money and next thing you know they are taking on more risk than they should be and they are holding their pools for longer trying to make additional spread income and the whole thing blows up on them.

So we are setting this up with pretty strict parameters and we intend to stick them to the best we can.

Brandon Dobell – William Blair & Company

Okay. And as you think about the bridge loan fund, the interim loan fund that you guys have going right now, any (inaudible) CMBS platform. How much crossover either in individual properties or I guess potential customer base if you want to use that term, how much crossover overlap you guys expect to have? There's multiple customers that you are doing everything with or should we expect a broadly different base of people that you are working with, for example, on the bridge loan versus the interim loan fund.

Willy Walker

So we have plenty of demand for the bridge loan product with our existing client base and because many of them right now in the cycle brand and are going from if you will simply refinancing assets to I mean if they don't want to buy an asset at 4.5 cap, the way to go and create value is to buy a C asset that might be 65% leased for some (NYSE:TI) into it, reposition it, lease it back-up and make some real money. And so some of the major developers that we work with are either putting shovels in the ground, to just do construction projects or they are doing equity. And so this is a product that will meet the demands of that existing client base.

As it relates to CMBS or the separate account initiative the issue there is that we today lose deals to those sources of capital and as you well know those sources of capital were structured distinctly. If you want to get a higher leverage loan or if you are in the manufactured housing business and you have a site that has a portion of it in the flood zone, Fannie and Freddie -- Fannie, excuse me Freddie doesn't lend on manufactured housing but Fannie doesn't allow for the income in the flood zone to be used as income in underwriting that loan.

CMBS lenders don't care about it. If there is a property, if there is piece of the property that's in the flood zone they will include that in their NOI calculation. So as a result of that you can do things in a CMBS structure, you can't do with the agencies today. So as we roll out our CMBS and as we look at doing longer term fixed rate financing in a life insurance company model in the separate account, we're going to be creating sources of capital that there is true investor demand for today and that quite honesty you're losing deal flow to today.

So the idea here is that we will have the ability to lend on those deals with proprietary capital or we will be able to broker those deals off to another source of capital. We in no way expect to win a 100% of the deals that come to us just because we have these offerings up and going. And so the people who are brokers on our platform will still have the opportunity and the ability to go out to all sources of capital because quite honestly there are plenty of sources of capital that are going to beat us on giving deals.

Brandon Dobell – William Blair & Company

Okay, and final quick one for me, doesn't sound like there is going to be any exposure to new construction activities, there is going to be still refinancing, repositioning, acquisitions things like that. I want to make sure I understood how these platforms are going to be positioned.

Willy Walker

Yes, no right now nothing as it relates to construction. As you know the realm of the commercial bank, and they will continue we'd assume to be the dominant providers of construction financing and other than our d4 program with HUD Brandon where we are doing construction lending through the d4 program, but other than the d4 program at HUD we do no other construction lending.

Brandon Dobell – William Blair & Company

Okay, perfect, thanks a lot.

Willy Walker

Thank you.

Operator

And we will take our last question from Cheryl Pate with Morgan Stanley. Please go ahead.

Cheryl Pate - Morgan Stanley

Hi, good morning. Most of my questions I think have been answered but just a couple of quick ones. I guess can you first of all may be help us reconcile the origination guidance $10 billion to $12 billion with your earlier comments about $2 billion to $3 billion in capacity per quarter? I guess sort of if you take the high end of that we kind of get to the midpoint. So I am wondering what else is sort of baked in there to get to sort of high end of guidance.

Willy Walker

So Cheryl my comments on two to three was really focused on margin if you will or where you are going to get margin expansion from where we were this quarter. The 2.3 to 3 is what we have established for Q2 and as you had seen us well, just in Q4, we were at the high end of that number in Q4 of last year. As a very if you will newly emerged company. And so it is our expectations that through the coming quarters we continue to see the value of our brand and our team. And that as we move through the year we might give you higher guidance as we go into future quarters who knows but obviously it all needs to come together to get us to our $10 billion to $12 billion by the end of the year. And as I said previously we believe we have the team on the ground, and the origination capacity to be able to do that number.

Cheryl Pate - Morgan Stanley

Okay, great. And then just on the margin side you spoke to sort of gain on sale sort of being in line with quarterly average for prior year and understanding that there is sort of this one large loan in the quarter, I guess just sort of thinking forward as we look at the MSR gains in particular and as HUD back online and Fannie -- sorry Freddie and HUD are sort of the larger MSRs associated with some - how do you think about that MSR gain overall as the capital market piece comes back which am I understanding there is no MSR booked against that.

Willy Walker

You're correct on that, other than when our capital market originators originate a loan for Fannie or Freddie or HUD where we do obviously book an MSR. I think one of the things to your note this morning Cheryl I think one of the things in the MSR number is that as we've discussed before the MSRs we book on a Fannie, Freddie or HUD deal are distinct. And we don't break those out but we have clearly given you and other analysts ranges as it relates to what kind of MSRs we book based on the servicing fees we make on those loans.

And so when we put out the percentage of business that we do with Fannie, Freddie and HUD in the first quarter, and we are happy to sit down and talk through, it was surprising to me that there was a surprise as it relates to the MSR calculation just because your model actually in the past has worked very, very clearly on that and so because there was a disconnect there I don't think it was all due to that one large Fannie Mae loan. And so it would be interesting for us to sit down and have a conversation about that at the appropriate time.

But just more generally on it, HUD is back. But as I said their commitment authority throughout the year is something that a lot of people are focused on but we have a very strong HUD pipeline and a great HUD group and we are working very diligently to get as much of our deal flow into HUD as quickly as possible to get as many commitments from them as we possibly can.

Fannie is clearly where we make the most from our gain on sale margin basis. And we had very good 185% quarter-on-quarter growth with Fannie Mae. We are the largest Fannie Mae (sellers) in the country and we are working very hard to do as much Fannie Mae business as we possibly can. Freddie has been and we have had just a fantastic success with Freddie Mac early in 2013, as you can by 508% growth quarter-on-quarter and Freddie is less comparable business from an MSR standpoint but it's still fantastic business. And so we love seeing the growth that we have with Freddie Mac year-on-year and year-to-date we are one of the largest Freddie seller of services in the country. And we plan to continue to grow that business line.

So I think one of the tricks here will be for us to try and both be very, as clear as we possibly can be, as it relates to our origination volumes and what we are looking at through the various executions. But at the same time as I said that we will shelve, it's very difficult for us to be able to figure out what percentage of our quarterly volumes are going to be in what bucket and the economics on those various execution as you know are quite distinct. And so we will try and be as clear as we possibly can but I'd go back to it that if you look at our overall year we are still looking at that 10 to 12 and I believe that most of the models out there are built off of our historic percentages that what percentage of our business was with Fannie what was with Freddie, what was with HUD and what was with capital markets.

A final point I'd make is you mentioned the capital markets business. I think that, that business has a lot of growth opportunity to it. We have added in that area. That is clearly a lower margin business. But as we build up these proprietary capital sources, the only way for us to gain access to that deal flow through our own distribution network is to build up that capital market business. So we as I said to Brandon we will continue to look to hire talent in the southwest and the west. And build that access to deal flow in non-multi-family assets such as hospitality, office and retail.

Cheryl Pate - Morgan Stanley

Okay, great appreciate the additional color there.

Operator

And we have no further question at this time. I would like to turn it back to our presenters for any closing remarks.

Willy Walker

Great, thanks Ed. Very nice to have all of you with us this morning. Thank you for taking the time. And we look forward to talking to many of you in the coming days and weeks. Thanks.

Operator

This does conclude today's conference. You may now disconnect and have a wonderful day.

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