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Walker & Dunlop, Inc. (NYSE:WD)

Q2 2013 Earnings Conference Call

August 8, 2013 08:30 ET

Executives

Claire Harvey - Vice President, Investor Relations.

Willy Walker - Chairman, President and Chief Executive Officer

Steve Theobald - Executive Vice President, Chief Financial Officer and Treasurer

Analysts

Cheryl Pate - Morgan Stanley

Jason Stewart - Compass Point

Brandon Dobell - William Blair

Whitney Stevenson - JMP Securities

Bose George - KBW

Operator

Welcome to the Walker & Dunlop’s Second Quarter 2013 Earnings Conference Call and Webcast. Hosting the call today from Walker & Dunlop is Willy Walker, Chief Executive Officer. 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 10 AM Eastern. The dial-in number for the replay is 800-688-7339. 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 - Vice President, Investor Relations

Thanks Jack. Good morning, everyone. Thank you for joining the Walker & Dunlop’s second 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 point for much of what Willy and Steve will touch 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 statements 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 the SEC.

I will now turn the call over to Willy.

Willy Walker - Chairman, President and Chief Executive Officer

Thank you, Claire and thank you everyone for joining us this morning. The second quarter marks another strong quarter of financial results for Walker & Dunlop with solid growth in loan volumes, revenue, and net income. I will talk through our origination volumes and some of the macroeconomic and political issues impacting our business. Steve will then provide details on the quarter’s financial results and I will close with an update on our strategic initiatives and what we see happening for the rest of 2013.

During our remarks, we will make reference to slides posted on our website this morning. I will start on slide four. We originated $2.6 billion of loans in the second quarter, up 91% over last year. This is fantastic growth for Walker & Dunlop and is dramatically higher than the industry growth rate of 7%. The mix of our business during the quarter with Fannie Mae at 30%, Capital Markets at 30%, and Freddie Mac at 24%, and HUD at 16% reflects the significant diversification of our business as we provide our customers with the very best execution for their financing needs.

Let me discuss each of these executions in turn. Fannie Mae was generally our largest and most profitable business. In Q2, 2011, Fannie Mae was 42% of our origination volume. In Q2, 2012, it was 46%. This quarter, it is only 30% primarily due to Fannie Mae adjusting to their new lending capital and Walker & Dunlop working to understand what loans and what markets Fannie Mae wanted to be in. It is our understanding that we are still neck and neck with one other lender to be Fannie Mae’s largest partner.

And if you look at our Fannie Mae volumes over the past three years, our aggregate future originations of Fannie Mae have grown from $555 million in 2011 to $610 million in 2012 to $772 million in 2013. That’s almost 40% growth over two years, which is fantastic just not as rapid as the growth in our other executions. We have a very strong partnership with Fannie Mae and understand today much more clearly how they are managing to the FHFA cap. Fannie Mae has plenty of money to lend throughout the balance of the year and we are extremely focused on our naming the number one Fannie Mae DUS lender in 2013.

Our capital markets originations were $758 million in the second quarter, up 87% from Q2 2012. During 2012 we made investments to add additional capital markets origination teams to the company and we saw the direct benefit of this investment during Q2 as life companies, CMBS and banks were all aggressively lending. Our capital markets business is a key element of our growth strategy and we will continue to recruit talent to our platform. In July we brought on industry veteran Bill Wein to lead and grow our capital markets business.

Investor should remember the Walker & Dunlop strategy is not to transform our lending platform into a brokerage platform. The growth in our capital markets business to expand our origination, gain access to new clients and deals and simultaneously to grow our proprietary capital solutions, so we not only can broker deals to other capital sources, but also lend on deals with capital we control. Our HUD volumes in the second quarter were $414 million, a record high for us. The volumes in the quarter were due in part to carry over from the disruption we saw in HUD’s commitment authority in March, but also due our variable DUS pipeline of HUD business.

We continue to see high demand from our customers for the HUD product due to the relatively lower rates and longer term that HUD loans provide. It is likely that HUD will run out of commitment authority during the third quarter just as they did in March. This will impact our HUD volumes in Q3, but given our expectation that a continuing resolution will be passed by congress at the end of the quarter our strong pipeline should position us well for a solid Q4 and total 2013 volume.

We are growing dramatically with Freddie Mac and it is great to see. We did $616 million with Freddie in Q2 2013 up from $230 million in 2011 and $223 million in 2012. We believe we have moved up from the fifth largest Freddie Mac seller servicer to third. And we are very focused on continuing to gain market share. Our ranking at this time of the year is not issued or confirmed by Freddie Mac but simply our understanding of where our loan origination volumes rank us year-to-date.

Let’s turn for a moment to the GSE’s, the political debate and what we see happening along those lines. Q2 was the first quarter that the GSE’s operated under the FHFA imposed cap of $26 billion of annual lending for Freddie Mac and $30 billion for Fannie Mae. It is our understanding from both industry discussions as well as public filings that Freddie has lent $14 billion of its $26 billion and Fannie has lent $16 billon of its $30 billion. So, both are over 50% of their annual limit half way through the year. But it’s important to understand how the GSE’s and Walker and Dunlop account for loan origination to fully understand annual lending capacity.

On Walker & Dunlop rate locks alone with Fannie or Freddie we’ve recognized the revenue associated with that loan. However, Fannie and Freddie recognized a loan when the loan is delivered to them by Walker & Dunlop, typically 30 days to 45 days after rate lock. Therefore loans rate locked by Walker & Dunlop and other lenders during the last several weeks of the year will likely account towards the GSE’s 2014 funding levels not 2013.

Two significant questions remain, real FHFA reduced Fannie or Freddie’s multi-family lending businesses again in 2014 and will any legislation be enacted that could materially change the GSE’s next year. As it relates to FHFA there are two issues we are tracking closely. First, the nomination of Congressman, Mel Watt, the head of FHFA was voted upon by senate banking committee and is now awaiting a floor vote in the senate. There will need to be some significant political horse-trading to get Watt confirmed. But if confirmed he would likely bring a very new approach to HFA and its annual score card.

Second, regardless of who the Director of FHFA is there is a chance they propose continued reductions to multi-family in the 2014 score card. If FHFA is watching the political debate on Capitol Hill with regard to Fannie Freddie reform. One would think they will not impose continued cuts to Fannie and Freddie’s multi-family businesses. Given the legislature framework currently gaining momentum, senators, Bob Corker and Mark Warner, have introduced legislation in the Senate that would wind down Fannie and Freddie over a five-year period and replace them with new federally mandated entity to provide government mortgage insurance with one major difference, private capital must take the first loss position and since both Fannie Mae and Freddie Mac’s multifamily businesses have private capital taking the first loss position today, the Corker-Warner Bill says the Fannie and Freddie’s multifamily businesses should remain as is.

Now there is clearly a disconnect between winding down Fannie and Freddie over five years, yet leading their multifamily businesses as is, but those issues will likely be worked out as this legislative framework moves forward. There are four very important teams that have developed during Q2 with regard to Fannie-Freddie reform. First, the bipartisan bill in the senate are gaining momentum, while the republican bill in the house has been described as extreme and not legislatively viable.

Second, risk sharing where private capital takes the first loss position on federally insured mortgages; something we have been promoting since Fannie and Freddie went into the conservatorship is on the table and gaining support. Third, Fannie and Freddie’s multifamily businesses performed exceptionally well during the downturn have shared rest between the private sector and government and don’t need to be reformed. And finally with the distance between the senate bill and the house bill, even if Corker-Warner did gain momentum, it seems unlikely any legislation will be passed before the 2014 mid-term election and possibly not until after the 2016 presidential election if the senate remains controlled by the democrats.

In summary, although the political landscape appears headed in a positive direction with regard to Fannie-Freddie reform, we are not holding our breath at anything significant happens in the near future. We continue to watch the legislative process closely, Fannie-Freddie remain great partners. However, as you can see from our Q2 financials, we continue to invest and diversifying our business to minimize the impact of any future changes to the GSE.

Let’s turn for a moment to the macroeconomic environment and its impact on our business. Although, interest rates ran up at the end of Q2 and clearly cause purchasers of properties and borrowers for refinancing to pause for a moment during the most volatile period. The Federal Reserve has worked tirelessly to reinforce its low interest rate and strategy and the 10-year treasury appears to have settled into a range of 250 to 270. Most owners at the commercial real-estate would like to finance as much as they possibly can at these rates.

At Walker & Dunlop’s annual summer conference in Sun Valley, Idaho in July, I asked the 250 conference attendees whether we were in the best of times or worst of times, 249 hands went up for best of times and one hand went up for worst of times that may have been a somewhat bias pole, as the conference attendees were sitting in beautiful Sun Valley, but I believe that reinforces the sentiment we get from the majority of our clients. Times are good. We had opportunities to deploy capital via acquisition are limited. This is leading many of our clients to focus on development as well as value add acquisitions in rehabs which drives up demand for interim for bridge financing. This is exactly why we are so excited about the large loan bridge program we announced earlier this week.

Let me turn the call over to Steve to dive into our financial results and I’ll come back to discuss our outlook for the rest of 2013. Steve?

Steve Theobald - Executive Vice President, Chief Financial Officer and Treasurer

Thank you, Willy and good morning everyone. I’m going to discuss our second quarter financial highlights as well as provide some prospective on how are more diversified and sustainable business model is expected to perform going forward. Net income for the second quarter was $14.5 million or $0.42 per share. Adjusted net income which excludes selective expenses relating to the acquisition of CW Capital was $15.3 million or $0.44 per share.

Operating margin for the quarter were 26% and adjusted operating margin was 28%. This compares to net income of $9.3 million or $0.42 per share and operating margin of 32% in the second quarter of 2012. Total origination volume of $2.6 billion was up 91% from Q2 ’12 and right in the middle of our guidance at $2.3 billion to $3 billion. Total revenue was $90.7 million, a 94% increase over Q2 ’12. Our origination volume this quarter demonstrated not only our industry leading growth, but also the improved diversity of our business model.

We are pleased with our overall production levels and continue to see strong demand from our customers and great execution from our producers. Going forward, we expect the capital markets will continue to be a high percentage of our overall volume and of course we will still do a much business as we possibly can that Fannie, Freddie, and HUD as they are still the dominant providers of capital to the multifamily industry at very attractive rates and terms.

On slide 5, you can see the trends in our mortgage gains which were at 246 basis points for the second quarter, down from 254 in the prior year quarter and off our three-year historical average of 262 basis points. Origination fees have helped steady over time was a decline in relative volumes of our Fannie originations has resulted in lower gains attributable to mortgage servicing rates.

Additionally, our diversification is taking place, not only with respect to our sources of capital, but also at the underlying product level. For example since the CW acquisition, we have originated a significant amount of adjustable rate loans due to GSEs. These structured arm loans have lowered mortgage servicing rates and fixed rate loans due to their prepayment flexibility. Due to these factors, we expect that our overall gain on sale margin going forward. We look like it has the last two quarters at 245 basis points. It is important to point out that we have not seen margin or servicing fee degradation at the individual product level, but rather than mix of loans we are selling in the current market environment is driving our margin trends.

The point of all this is the company has never been more diversified in terms of its excess to capital and product offerings to customers. Diversification means less reliance on the GSEs, broader capabilities, we can offer to our customers and continued opportunities to grow. The impact of diversification is lower margins than we have reported historically when we were predominately a fixed rate Fannie Mae lender, but we had all our eggs in one basket and our increased scale in diversified product offering makes our business far more durable while still being highly profitable.

Another important element of our diversification is the continued growth in our servicing portfolio. As shown on slide 6, a $37.9 billion, our servicing portfolio is 116% larger than a year ago and continues to grow adding net loans of $1.1 billion during the second quarter. We are now the 9th largest commercial mortgage servicer in the country. Our weighted average servicing fee remains at 24 basis points and the portfolio generated $22.4 million of revenues during the quarter. Our servicing portfolio produces not only annuity like income, but also a steady and growing stream of cash flow to the company.

Total expenses during the quarter were $66.9 million, an increase of 112% from the second quarter of 2012. The increase in total expenses when compared to the year ago quarter was driven by investments made in growing and diversifying our business than the amortization expense in write-off associated with the servicing portfolio. Let me walk through these in more detail.

As you can see from slide 7, personnel cost as a percentage of revenues was 41% in Q2, higher than the 37% from the prior year quarter, but in line with our expectations. Personnel expense was $37.3 million, up from $17.4 million in the second quarter of 2012 is our employee base more than doubled from a year ago largely as a result of the CW acquisition. During the last 12 months, we have added 27 producers to our team. Our business relies heavily on the relationships in talent of our production team and over the course of the last year, we have taken necessary steps to retain as well as attract some of the best talent in the industry.

The incremental cost of these retention efforts in the first half of 2013 was $1.8 million with half of that expense recognized in the second quarter. In addition, we have invested $2 million in our proprietary capital initiatives year-to-date, a $1.7 million increase from the same period last year, $1.5 million of this expense occurred in the second quarter. These expenses are primarily for the salaries of the additional personnel brought on to lead our proprietary capital efforts. We expect to incur additional expenses as we continue to invest in these initiatives, but with the launch of the large loan bridge program and expected growth in our interim loan program we will begin reporting increased revenue for immediate investments as well.

Slide 7 also shows that amortization and depreciation expenses grown from $6.7 million or 14% of total revenue to $17.7 million or 19% of total revenue in the second quarter of 2013. The increase was primarily due to the 116% increase in the servicing portfolio and related mortgage servicing rights, and a 74% increase in mortgage servicing rights prepayments. As a servicing portfolio grows and our servicing revenue increases, so will the amortization expense associated with the portfolio.

The remainder of our operating expenses totaled $9.8 million for the quarter, an increase of 49% from the prior year. Recorded in the current expense is an $825,000 fee for the restructuring at CW capital from a headquarters’ office, which will save us more than $500,000 annually on rent expense. Absent that one-time expense, other operating expenses were up only 37% year-over-year and represent 10% of revenue in the second quarter of 2013 down from 14% of revenue in Q2 2012 as we leverage the increased scale of our business.

Turning now to slide 8, our credit risk remains at benign levels. Our provision expense of $751,000 was in line with our provision expense in Q2 ‘12, but note that this year’s is against a portfolio that is almost doubled in size. During the quarter, we settled down six loans with Fannie Mae for slightly less than what we have previously reserved for. 60 plus day delinquencies increased slightly to 6 basis points in the portfolio from 5 in the second quarter of 2012. When times are good, it is easy to forget about credit risk, but we don’t take our stellar performance for granted. We remain very focused on continuing to make sound credit decisions which has served us well especially during the worst of times.

I wanted to briefly discuss our balance sheet and capital structure. As you will see from slide nine, our balance sheet shows significant growth from a year ago. We ended the second quarter with $66 million of operating cash, tangible net worth of $317 million, and a debt to equity ratio 0.2% all improved from a year ago. Because of our strong earnings growth, stable and growing cash flows and extremely low leverage, we have a tremendous amount of financial flexibility. We are exploring ways to take advantage of the strength of our balance sheet as we look at how to best fund our strategic initiatives while optimizing our capital structure around the twin objectives of sound risk management and creating shareholder value. Despite the recent run up in rates, the debt markets remained very attractive, not just for our customers, but for us as well, and we will be looking to take advantage of these markets.

Before I turn the call back over to Willy, let me make one more comment about our operating margin. Since joining the company at the beginning in the second quarter, I have been looking at our margins relative to our competition. As I am sure all of you discovered well before I did, it is difficult to find the exact comparisons to Walker & Dunlop as we are one of the few public pure-play commercial real estate finance companies out there. And while we have no direct comparative set, we have looked at the financial statements of various real estate services firms, mortgage REITs, and our bank competitors.

I believe our combination of growth rate and margin is among if not the best in our industry. The key to maintaining attractive growth in margin is to continue making investments in our production capabilities, leveraging our scale and back office and overhead expenses, and maintaining the fantastic culture that made me decide to join this company. I believe we have created a compelling story by doing exactly that, and we will continue to manage the organization that way going forward.

With that, I will turn it back to Willy.

Willy Walker - Chairman, President and Chief Executive Officer

Thank you, Steve. So, where are we headed with this fast growing company that has fantastic clients, exceptionally talented people, and strong macro drivers as it relates to investors’ desire to own commercial real estate and strong loan refinancing volumes between now and 2018? I believe our Q2 results underscore the scale and diversification we have been building since going public, and investors should know as Steve just said that we are extremely focused on maintaining industry leading growth rates and profitability growth forward.

As you will see from slide 10, Walker & Dunlop’s originations grew at a compound annual growth rate of 47% between 2007 and 2012, the highest in the industry. So, we have had the highest growth rate of any commercial loan originator since the downturn and we are consistently told we are one of the best managed companies in the industry. We take both of these not as complements to rest upon, but rather a challenge to remain so. As we discussed earlier in the call, our strategy is to build out our Capital Markets business to gain access to new clients and deal flow, but also to raise capital, so we can either broker those deals off to other money sources or lend on those deals with capital we control.

Earlier this week, we announced the successful raising of capital to launch our large loan bridge program, a joint venture with a Canadian institutional investor and a U.S. real estate investment manager. We are thrilled to partner with firms of this caliber and the $850 million in new bridge lending capacity is a significant addition to our product offering. The appetite for bridge lending is strong as borrower shy away from buying properties at sub five caps and instead focus on value add investments and development. Another source of capital we have discussed with investors in the past is CMBS. We were very close to launching our CMBS platform in June, but our selected equity partner materially changed the terms of our partnership agreement. So, we backed away. We are currently engaged with several institutions to form a partnership that will allow us to launch our CMBS platform in 2013. Despite the volatility in CMBS at the end of Q2, we are still strong believers that CMBS will be an important capital provider to our industry over the coming years, and we remain focused on adding this capability to Walker & Dunlop and to our clients.

With regard to a public mortgage REIT, we have completed almost all the work to file with the Securities and Exchange Commission, but have decided to wait for now given the recent run-up in rates and overall market dynamics for a mortgage REIT IPO. We believe a mortgage REIT vehicle would be very beneficial to Walker & Dunlop, as a form of off balance sheet financing, but for now that strategy is on hold.

Finally, as we announced in May, we hired Brian Casey to spearhead our initiative to raise capital to provide long-term fixed rate financing to our clients. Brian’s extensive experience running one of the largest life insurance company lending platforms in the country is hugely valuable to our capital raising and capital deployment strategies. We have a tremendous origination platform that institutional capital appears to want to access. We are hopeful that we’ll have a separate account upon running before the end of the year.

I’d like to look back to where we started this call, highlighting the terrific loan origination growth we experienced in Q2 by originating $2.6 billion of loans, that’s more than we originated in all of 2009. As we look at Q3, which is typically a slower quarter for origination, we are faced with the challenge of HUD’s commitment authority and the GSE potentially slowing down origination to insure they had adequate capital for Q4. We are establishing Q3 origination guidance of $2 billion to $2.5 billion and revising our 2013 annual guidance to $9 billion to $11 billion.

We remained extremely focused on retaining our position as the largest Fannie Mae DUS lender moving up in the league tables with HUD and Freddie Mac and continue to diversify our lending platform by growing capital markets and raising proprietary capital. We are still clearly on the path to creating the premier commercial real-estate finance company in the United States and our current quarter’s financial and operating results show this. Two and half years ago, we went public at a market capital of approximately $220 million and near complete dependence on Fannie Mae and Freddie Mac at a time when most people thought the GSE’s were about to be shutdown.

Since then, we’ve invested time and capital to maintain our highly valuable GSE businesses. It also expanded our platform by growing our hard and capital markets businesses. We acquired CW capital last year and plenty of people doubted whether we could acquire, integrate, and grow our platform post acquisition. We have done just that while maintaining the exceptional culture and management practices that make Walker & Dunlop what it is today.

Our market cap is increased nearly three actions our IPO. We are one of the fastest growing commercial real-estate platforms out there. We invested in new business lines. We continue meeting our customers’ needs and all the while, we have grown the size of our servicing portfolio from $14.6 billion at the end of 2010 to $37.9 million today. We have produced dramatic growth in sales significantly diversified our lending platform, maintained high profitability margins and continue to build a long-term prepayment protected servicing asset that will benefit investors in good times and bad.

Finally, we remained the seventh best small and medium size company to work for in the U.S. in 2012, and we hope to be on the list again in 2013 with the addition of our terrific colleagues from CW capital.

With that, I’ll thank all of you for participating in today’s call and open the line for questions.

Question-and-Answer Session

Operator

The floor is now open for questions. (Operator Instructions) Thank you. Our first question will come from Cheryl Pate with Morgan Stanley. Please go ahead.

Cheryl Pate - Morgan Stanley

Hi, good morning. Just a question on given the rate environment and the move is on the second quarter. Can you speak to the benefit perhaps that you receive from prepayments in the second quarter and sort of how to think about the year ahead and sort of now the rates seems to have stabilized a little bit at this level?

Willy Walker

Good morning, Cheryl. So as it relates to prepayments in Q2, the majority of the prepayments in Q2 were in with HUD loans and so as a result of that we did not get prepayment penalties during Q2 for the majority of the payoffs that we had because it was very focused in our HUD portfolio, but the raising initiatives we’ve discussed before which is that as rates do move up many of our customers are looking at if you will what’s the straight point to pay a prepayment penalty and refinance at these lower rates. We haven’t seen a lot of that in the Fannie and Freddie portfolio so far, but there are plenty of clients of us who have 2014 and 2015 maturities who are pretty engaged on running calculations with us to figure out what the sweet spot is if you will?

Cheryl Pate - Morgan Stanley

Great. And then just on the lower guidance for the full year is that being driven sort of entirely by the lower Fannie Freddie volumes or how should we think about capital markets and potentially how would that being back on line as potential offsets?

Willy Walker

I guess, there are a couple of things there Cheryl. First of all as you know, we can grow our capital markets business dramatically and we plan to do that, but as it relates to the overall financial model it is not as profitable to us as our agency execution. And so what we did in bringing the guidance down there are couple drivers there. First of all as we have said before Fannie and Freddie is 10% reduction in 2013 is not a massive change except as you saw in Q2 we had a lot of work to do on figuring out what markets Fannie wanted to be in and what deals they wanted to do. As we just said had been very engaged in getting a better understanding of where they wanted to be for the rest of the year and they have plenty of capital put out. But I wouldn’t be surprised given that both of them are over half way through their annual allocations and Q4 is typically the largest loan origination quarter of the year that both of them are looking at deals in Q3.

I am wondering whether they want to put a ton of capital out in Q3 or wait and hold on to Q4. That is mitigated somewhat by the point we made in the call as it relates to how they account for loans and how we account for loans and their deliveries towards the end of the year. Well, the loans we rate lock at the end of the year will be pushed over to being deliveries to them in 2014. So, we see a very robust environment out there. There is a lot of financing activity going on, but I think by bringing the guidance down we are just trying to say to people look we are still very focused on doing as much business as we possibly can, but if you look at the volume we did in Q2 which we are extremely pleased with and also the guidance we’ve given for Q3. There are a lot of moving parts out there that we are working very hard to manage with but we thought that we would establish that guidance for the rest of the year.

Cheryl Pate - Morgan Stanley

Thanks very much.

Operator

And our next question comes from Jason Stewart with Compass Point. Please go ahead.

Jason Stewart - Compass Point

Hi, good morning. Thanks. On the large loan bridge program, Willy could you give us some more details around what expectations you have for leverage your fees, when you expect to start funding?

Willy Walker

Sure. Jason, first of all congratulations on your note the other day on taking a look at the overall environment and understanding that things are moving around out there if you will. I would – the large loan bridge program as I said we are thrilled with our two partners there. And I want to underscore how big accomplishment it is for Walker & Dunlop to have gone out and raise that much capital from two very established institutional investors to spearhead this effort. I think there is going to be a tremendous amount of opportunity going forward for us to raise capital in this manner and I think this is just the first step that investors will see of us growing our relationship both with these two investors and also other investors.

There is a significant amount of demand for bridge or interim financing due to what I mentioned in the call lot of people sort of shying away from buying assets to the sub-5 cap and just holding on to them. Many people are looking both at the development world as well as the active world and this fund plays perfectly into that. This is a large loan fund and we are fortunate to have an origination sales force that has access to lots of large deals. I would underscore that because in the CW acquisition we picked up a number of very large relationships with some producers now Walker & Dunlop who had the access to larger loans which will play right into this strategy.

And then as it relates to the specific fees Jason, we haven’t sort of issued a press release if you will on all the different components to it. We will make asset management fees on the fund and we will make origination fees as well as servicing fees, and the trying – and as it relates to leverage, we are not looking to lever this – they were getting 65% leverage I believe on it directly.

Jason Stewart - Compass Point

That’s right.

Willy Walker

Yeah, so we are getting 65% leverage on occasion and so we have moderate leverage for fund of this nature. And looking at low teens returns given where coupon rates are today and the type of leverage we put on it.

Jason Stewart - Compass Point

Okay, we could expect you to start funding these in the third quarter?

Willy Walker

We spoke to our – we announced it day before yesterday and I had three e-mails with one of our co-investors yesterday saying we are cranking and let’s get some deals in here and lets get going. So, we are very focused on it and getting as much as we possibly can going with them. It’s a great opportunity.

Jason Stewart - Compass Point

Okay, I appreciate the color there. And then one follow-up on the expenses, it sounds like a lot of the hiring and building for these business diversification efforts has occurred. Would there be an expectation that the growth rate there slows or is it still little bit more building to do little bit more expense to come in the second half for this year for those initiatives?

Willy Walker

We talked about and I’ll let Steve, do you want to add anything here. We talked about the fact that we’ve hired some super, super talented people. And I am thrilled with the hires that we have made both on our CMBS platform as well as our separate account platform and also for this large loan bridge program. And Jeff Goodman who runs all those efforts should be congratulated for all the talent that he has attracted to our platform. One of the big expenses that we were modeling Jason was the mortgage REIT and as we said in the call, we put that on hold for now. So we invested a bunch of time and effort in both our own resources as well as external particularly legal help in getting all that put together and so that is now on hold. So that doesn’t kind of continue to burn for a period we might have an appropriate time to look at that again.

And then we will really be looking at it from a capital standpoint really now that we’ve got the people here, we are putting the partnerships in place, it’s really kind of turns back to Steve as it relates to how much capital that we have or we’re putting into these ventures and as Steve highlighted in his comments our balance sheet right now is in such a form that he has got plenty of both cash on the balance sheet as well as borrowing flexibility to be able to potentially raise capital to put into these initiatives should we need additional capital.

Steve Theobald

The only things I would add are one we also continue to recruit capital markets and origination teams so I would expect they will still continue to see expenses related to those efforts as we find the right post to fit here. And then with respect to CMBS platform, which Willy mentioned once we get that signed up and upon running there will be some investment associated with that as well, but that runs out what really had to say.

Jason Stewart - Compass Point

Great, thank you.

Operator

And our next question comes from with Brandon Dobell with William Blair.

Brandon Dobell – William Blair

Thanks. Good morning. I want to make a couple of quick follow on comments on the expense structure given the pacing of the GSE origination doesn’t sound like you guys are going to make any change to the expense structure, I know commission flex have been flexed down other than the investment that you guys continue to make or have made in the diversification efforts, anything to talk about the expense structure in the back half of the year relative to the pace originations now versus your prior expectations.

Willy Walker

Brandon I think, I mean we are going to as we would always do look at expenses and where we think we are spending too much we are going to take action on that, but at this point from an origination perspective I don’t think we are looking at any adjustments to our expense base.

Brandon Dobell – William Blair

Okay, got you. And then Steve, in your comments on the balance sheet you talked about taking away into the balance sheet maybe some more color on what you guys are thinking of putting capital work in the large loan fund as an example of that, but what are kind of things that you guys looking at to take advantage of your financial position right now.

Steve Theobald

Yes. So, Brandon I think if you look at the structure of our balance sheet and the cash flow that we are producing right now I think we were underleveraged and so, I think there is an opportunity for us to accomplish couple of things. One is take advantage of interest rates and provide – we’re not talking about the crazy leverage, but so, don’t anybody get too excited there, but we’re looking at increasing the leverage in the company, which will make us more efficient on the capital side.

Brandon Dobell - William Blair

Okay.

Willy Walker

And then that will also then give us the increasing capital necessary to support some of these proprietary capital efforts. So, the large loan bridge program, the CMBS platform or interim loan program, all require capital contributions from us.

Brandon Dobell – William Blair

Yeah.

Willy Walker

This will be a way for us to finance those contributions over a longer period of time.

Brandon Dobell – William Blair

Got it and then maybe, Willy, given all the political flip balling back and forth, what’s your sense of next year of potential one more down take in the commitment levels or ceilings from Fannie and Freddie and I guess if there is change depending on who is whether its Mel Watt or somebody else is putting that position?

Willy Walker

Yes, it’s a perfect question if you will Brandon and obviously when that we don’t know the answer too as it relates to trying to read the tea leaves as I mentioned in my comments if FHFA is watching the political debate on capital held one would think that they wouldn’t ask for a continued decrease and at the same time you sort of you never know and you want know until they come out with 2014 scorecard. And so there is really almost right now for us it’s almost impossible to handicap by what I look at is the disruption if you will or the difficulty in understanding were Fannie was in Q2 was something of one-time event as they for the first time in their history had to deal with a cap and what’s the strategy did you with that cap. They have now done that and now are figuring out how they’re deploying capital as you saw in our numbers with Freddie Mac, I would put forth the Freddie really didn’t skip a beat, they stayed consistent in the markets and stayed consistent to the types of deals they wanted to and as you saw our quarterly volume with Freddie was it in all time high over $600 million and Freddie continues to deploy capital at a very if you will effective in efficient rate.

So if they took another 10% out in 2014 that’s bringing Fannie down to $27 billion and bringing Freddie down to $24 billion, $23.5 billion. And so you still have in the two of them if I just did the same thing again well over 50% of the capital it’s going to go into multifamily in 2014. So, there is still going to be huge players regardless of whether they get change in that manner or they’re making up for something else. But let you say that do a redo, it’s still a huge amount of capital and I think that the agencies will be better particularly Fannie at managing through any potential reductions.

The final thing I would say all of it, Brandon, is just that the agencies because FHFA came out their scorecard in March. The agencies were sort of already into Q1 when this scorecard came out. So, they have put in request that FHFA to come out with the scorecard earlier this year. So to come out with the scorecard in 13, so they sort of they know what they’re planning and budgeting to in 14. I don’t know whether FHFA is going to live up to that request and whether we’ll see something in the next couple months whether they’re going to wait as they historically have done into the fiscal year that they’re actually setting a scorecard for, but we could know sooner rather than later that’s I guess the end of today what I’m trying to say.

Brandon Dobell - William Blair

Got it, okay. And then one follow on from that, given the portfolio construction I guess with at risk loans versus loans without risk at Fannie and I think your comments really about trying to figure out where if anyone wanted to be with different types of programs. So, we expect an uptake or down take or no change and with that at risk portfolio proportion looks like kind of going forward?

Willy Walker

So, the at risk portfolio as you’ve seen has grown dramatically over the past couple of years both through organic origination as well as the acquisition of CW. I think that really as we look at the percentage of our businesses we do a Fannie Mae, it’s everything we’re doing with Fannie Mae is generally speaking for risk. As you know Brandon if we do larger deals, they are capped at $65 million of aggregate risk to Walker & Dunlop, and then everything above that we don’t take risk sharing on. And so I think the issue there that they will still be all the deals we do with Fannie Mae were still be at full risk. I think the point that I would underscore from Steve’s comments was that we have done a number of structured arms since acquiring CW and we didn’t do a lot of structured arms prior to acquiring CW, but some of them are larger clients and CW’s past clients like the dynamics of these structured adjustable rate mortgages.

And so when we are doing those deals, they are typically five and seven year deals and because they have greater prepayment flexibility to them than a standard 10-year fixed rate loan, we’re not – we book at MSR for the first year’s mortgage servicing rates, but beyond that we don’t book the servicing income as an MSR when we put them on the books. What that means is that when we actually originate those loans, we are getting our origination fee and we are booking a small MSR, but because all those loans have caps on them. The chance that they prepay in this market environment is very low and therefore what you will see is we pickup just a servicing income that comes in over the life of the loan and doesn’t have an offsetting amortization expense of having setup an asset that we are in the process of depreciating.

Brandon Dobell - William Blair

Okay.

Willy Walker

The bottom-line there is you don’t see it today, but we see it tomorrow if those loans stay on our books because they got very healthy servicing fees just like a standard fixed rate deal, except we’re just not booking non-cash income when we are originating them, we are just taking the cash flows half of them as they stand the books for 3, 5, 7 years.

Brandon Dobell - William Blair

Got it, it’s very helpful. I appreciate the color, thanks.

Operator

And we’ll go next to Whitney Stevenson with JMP Securities. Please go ahead.

Whitney Stevenson - JMP Securities

Hi, there, everyone, Willy, Steve and Claire. So I think you usually have some top-line seasonality with revenue ramping as the year progresses, and I’m just wondering if you can give us an idea of what percentage of personnel comp is fixed salaries and what percent is commission driven?

Willy Walker

Whitney, we have that – we have a slide everyone’s diving for our slides, we – I don’t have it right in front of me, but we let’s see do you want me to pause for a second or do you want me to send it to her?

Whitney Stevenson - JMP Securities

No, that’s fine. Is it in here?

Willy Walker

We’ve got it, Whitney, we’ve shown there has been a historic slide that we’ve had in past presentations which shows quarter-by-quarter, the fixed versus the variable and as you look at our history if you will and Q4 typically because that’s such a large origination quarter the variable kind of sky rockets up because you’re paying a lot of commissions and then in quarters like one and two we had lower volumes, your fixed expenses as a percentage of expenses comes up, but do you have the actual number? Do you want to send it to me?

Steve Theobald

I mean, the split right now is about 55 fixed, 45 variable. The variable includes not just commissions, but it’s also our discretionary bonus pool etcetera for the non-sales force, but its 55:45.

Whitney Stevenson – JMP Securities

So is that 55-45 split for first half or second quarter.

Willy Walker

That’s for the first half.

Whitney Stevenson – JMP Securities

Okay, perfect, thank you.

Willy Walker

Yeah.

Operator

We’ll go next to Bose George with KBW. Please go ahead.

Bose George – KBW

Good morning. To the extent of the GSEs are not providing financing because of their caps, where do you see some of those borrowers getting their funding or is it too early to tell?

Willy Walker

Good morning, Bose. The markets are plenty active, as everyone talked about private capital coming back to the U.S. mortgage markets and the fact that Fannie and Freddie are dominating the single family space, I wish numbers of congress would come and hang out in our offices and see the competitive set to go after deals that we are lending on. As you have seen in the volumes from our competitors, there are CMBS is back was really cranking pre-interest rate run-up and took a pretty significant pause, Bose, in sort of the last six weeks of the quarter as rates started to move and we’ve got some significant volatility in the market. CMBS is back, making coats and actually processing business, but that sort of that’s the typical cycle right, they are cranking when things are pretty stable and then the moment there is some significant volatility they are taking a pause seem where the markets kind of shake out and then coming back in. The banks are still aggressively lending because they are looking for yields. Some bank competitors have gone to doing longer term fixed rate loans might tell me you would tell me that their CFOs and Treasurers at some point are going to walk in and say our capital structure is not designed to be doing 7 and 10-year fixed rate lending. And we ought to get back to doing construction loans and three and five-year variable rate loans or adjustable rate loans. But for right now, some of the banks are going long and going fixed, which is a competitive, if you will, a significant competitor out there.

And then the life insurance companies got out of the gates extremely fast in 2013, put a lot of capital to work in Q1 and continued to put capital work in Q2. We know a couple of the smaller programs have pulled back, because they basically run out of money. But you may have just seen announced this week that MetLife got a big separate account from SunTrust, I think it was about $5 billion that MetLife got from SunTrust in a separate account. So, someone like MetLife who I believe put out $9.5 billion last year just got a separate account allocation from SunTrust for, I don’t know, how much they plan to put out of that $5 billion in 2013. But the life insurance companies, and particularly to big guys like MetLife and New York Life and others, they will have plenty of capital to continue to be an active lender in the market this year.

Bose George – KBW

Okay, great. That’s helpful. Thanks. And then actually on the CMBS, is that initially you guys are going to be – have be a conduit, but could that tie into the commercial mortgage REIT as well where you essentially hold some of that risk? Is that the idea?

Willy Walker

That’s clearly the idea given that the REIT is on the shelf right now, not something that we get to right away, but sure, that’s the flexibility, if you will that the REIT would provide us with as it relates to a funding source for potentially the conduit and then for all of our lending operations will be great. And we are still we’d love to have that vehicle, but we have also got a lot of – I think right now, if you think about it from a prioritization standpoint, Bose, as Steve underscored, our platform is more diverse today than its ever been, but we underscore that diversification with making sure that we are raising proprietary capital that we can feed into our distribution network and the source of capital, if you will, or the type of capital that is most needed today is that long-term fixed rate capital that Fannie and Freddie provide that we need to have in case Fannie and Freddie continue to shrink their operations. And so we are very focused on both the CMBS platform as well as the separate account, because that type of capital matches up perfectly with the customers need for that type of capital.

Bose George – KBW

Okay, great. Thanks.

Willy Walker

Yes.

Operator

And I would now like to turn it back over to Mr. Willy Walker for any closing or additional remarks.

Willy Walker - Chairman, President and Chief Executive Officer

Appreciate all the questions and all the focus that the analysts have on W&D. Q2 is a great quarter. Everyone at Walker & Dunlop had a fantastic quarter and we are already solidly into Q3. And then I just close the call by saying we haven’t even come up on the one year anniversary of the acquisition of CW and we have a company that is operating at a very efficient and a very integrated level right now, well within a year of having brought on basically doubling the size of the company. And as an individual, I have tried exceptionally hard and spent a lot of time on making sure that we bring these two companies together and maintain a very consistent culture and continue to do things the way that both Walker & Dunlop and CW did them previously to meet our customers’ needs, continue to grow rapidly, and maintain a high profit margin in our core business. And we have done just that. So, thanks everyone for joining us today and we’ll be talking to you soon.

Operator

Thank you. This does conclude today’s conference call. Please disconnect your lines at this time and have a wonderful day.

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