Walker & Dunlop, Inc

Good morning. I'm Kelsey Duffy, Senior Vice President of Investor Relations at Walker & Dunlop, and I would like to welcome you to Walker & Dunlop's fourth quarter and full year 2022 earnings conference call and webcast. Hosting the call today is Willie Walker, Walker & Dunlop Chairman and CEO. He is joined by Greg Forkowski, Executive Vice President and CFO. Today's webcast is being recorded, and a replay will be available via webcast on the Investor Relations section of our website. This morning, we posted our earnings release and presentation to the investor relations section of our website, www.walker.lab.com. These slides serve as a reference point for some of what Willie and Greg will touch on during the call. Please also note that we will reference the non-GAAP financial metrics, adjusted EBITDA, and adjusted core EPS during the course of this call. Please refer to the appendix of the earnings presentation for a reconciliation of these non-GAAP financial metrics. 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 describe our current expectations, and actual results may differ materially. 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, and we expressly disclaim any obligation to do so. More detailed information about risk factors can be found in our annual and quarterly reports filed with the SEC. I will now turn the call over to Willie.

Thank you, Kelsey, and good morning, everyone. 2022 was a challenging year for the debt markets, commercial real estate industry, and Walker & Dunlop. Since going public in 2010, we have generated outstanding shareholder returns of over 800%. Yet in 2022, not only was our stock price down precipitously, but we did not achieve our annual financial targets. While the Federal Reserve raising interest rates by 425 basis points, is the direct reason for the commercial real estate financing and sales markets falling apart, we take full accountability for our 2022 performance. On this earnings call last year, we outlined significant growth for Walker & Dunlop, not knowing the extent of the dramatic, of the Federal Reserve's tightening plan. And as the rate hikes got more consistent and significant, the commercial real estate transaction market slowed down dramatically. We closed $11.2 billion of total transaction volume in Q4, down 59% from Q4 of 2021, generating total revenues of $283 million, down 31% from Q4 of 2021. Diluted earnings per share was $1.24, down 49% from the previous year, reflective of the dramatic deceleration in capital markets activity we saw in the back half of the year. Full year debt financing and sales volume was $63 billion, down only 7% year over year, generating revenues of $1.3 billion flat from 2021. Full year diluted earnings per share was $6.36, down 22% from 2021, primarily due to significant declines in mortgage servicing rights from our Fannie Mae and HUD loan originations. The dramatic drop in MSR revenues was due to pricing with Fannie Mae and overall lending volumes with HUD. The rising interest rate environment in Q3 and Q4 forced us to adjust pricing on our Fannie Mae loans to make deals work for our clients, which resulted in lower guarantee fees for Fannie Mae and lower servicing fees for Walker & Dunlop. To understand the magnitude of this fee compression, had our 2022 Fannie Mae loan originations been done with 2021 average servicing fees, it would have added over $2 of diluted earnings per share on the year, a 31% increase over our reported earnings per share. As the Fed slows the pace of tightening and rates stabilize, we expect servicing fees to revert to historic profitability levels. Our Q4 HUD volume of $187 million was well below budget. And while we finished the year as the number two HUD lender, $1.1 billion of loan originations was less than 50% of our annual budget expectation. HUD has plenty of capital, particularly for multifamily construction loans, but until HUD modifies their lending programs to be more market competitive, deploying their capital will continue to be challenging. Even with the decreased profitability in Fannie and dramatically lower volumes with HUD, our scaled lending partnerships with Fannie Mae and Freddie Mac showed their value in the third and fourth quarters. Floating rate loans were in high demand in Q4, an area of the market Freddie Mac dominates, and we closed $2.3 billion of Freddie loans, up 49% year over year. Our Freddie Mac originations totaled $6.3 billion for the year, making W&D the third largest Freddie Mac Optigo lender, up one position in the league tables. As I begin to talk about our Fannie Mae volumes, we're going to run a graphic produced by CoStar that shows Walker & Dunlop's incredible market share gains with Fannie Mae over the past five years. Our Q4 volume with Fannie Mae was only $995 million due to Freddie Mac's competitiveness. Our full year 2022 Fannie Mae volume of $10 billion brought us to 16.5% market share, an all-time high, and solidified our ranking as the number one Fannie Mae dust lender for the fourth consecutive year. Our Fannie Mae lending volumes have consistently grown as this chart clearly demonstrates, and we have taken significant market share from the competition over the past five years. We ended the year with combined GSE market share of 12.7%, making us the largest GSE lender in the country for 2022, something we have never done before. This scale, with the two largest providers of capital to the multifamily industry, will pay significant benefits to Walker & Dunlop and our clients in 2023 and beyond. As large banks, CMBS lenders, debt funds, and life insurance companies stepped back from the market in Q4, our capital markets team had a solid quarter, closing $4.4 billion in financing volume. While this volume was off 66% from Q4 of 2021, it was an accomplishment given overall market volatility and lack of liquidity. On the year, our debt brokerage volume totaled $25.9 billion, a decrease of 13% from 2021 when capital was free and debt funds were lending on any asset they could find. Q4 multifamily property sales volume of $3.3 billion was similarly down 64% year over year, but $3.3 billion was still healthy volume during the quarter. Our full year 2022 sales volume was $19.7 billion, up 2% from 2021 in a market that was off 17%. As this slide shows, on institutional size multifamily sales, W&D grew market share from 7.8% in 2021 to 10.2% in 2022. Look at the precipitous fall with some of our largest competitors on this slide. W&D, which only entered this market in 2015, is firmly in the mix to have the largest multifamily sales platform in the country. The Mortgage Bankers Association recently released their commercial real estate finance forecast, which as you can see on this slide, projects the 2023 multifamily financing market to decline 16% to $384 billion, and the total commercial real estate finance market to be down 15% to $684 billion. Freddie Mac's 2023 multifamily market estimate is larger at $440 billion. A market of this size, with the GSEs playing an outsized role, presents a huge opportunity for Walker & Dunlop to grow volumes and capture market share. And looking to 2024, the MBA estimates that multifamily origination volumes grow 26% to $486 billion, and total CRE originations grow 32% to $906 billion. These estimates are compelling. And just as Walker and Dunlop outperformed during the great financial crisis and COVID pandemic, our team, brand and technology should outperform once again. Many of our competitor firms have announced layoffs. We assume that rates stabilize in 2023 and financing and sales activities increase in the back half of the year. So we're holding on to our entire team for the following reasons. First, we're an extremely efficient company. As you can see on the left-hand side of this slide, our revenue per employee is dramatically higher than the competition, at right around $1 million per employee. As the middle graph shows, our efficiency ratio, defined as SG&A expense as a percentage of total revenues, is dramatically better than the competition. Finally, as you can see on the right-hand graph, our adjusted EBITDA margin is at the high end of the peer set by a significant margin. Second, we have licenses to access counter-cyclical capital from Fannie Mae, Freddie Mac, and HUD, and achieve record market share with the GSEs in 2022. Third, we are exceptional with credit and only take risk on multifamily properties. We have seen no credit degradation in our at-risk loan servicing portfolio. And with an average debt service coverage ratio of over two times and no credit risk whatsoever on office buildings nor construction loans, we feel very good from a credit perspective. Fourth, we have durable long-term revenue streams from our $123 billion servicing portfolio and $17 billion asset management business. Q4 servicing revenues were $77 million and topped $300 million for all of 2022. Added to that servicing revenue was escrow income of $53 million, which started the year at $2 million in Q1 and grew to $26 million by Q4. During the fourth quarter, cash revenues from mortgage originations, property sales, servicing, and asset management, and escrows drove adjusted EBITDA to $93 million. bringing full-year EBITDA to $325 million, up 5% over the previous year. The strength in EBITDA is reflective of the business model we have built and clearly differentiates W&D from some of our more transaction-focused competitors. Finally, we are a great place to work, a designation earned for eight of the last 11 years, and have a history of zinging when others zag. We grew during the great financial crisis and were the first mortgage company to go public after the great financial crisis in December of 2010. And our financial performance during the pandemic wildly outperformed, allowing us to make three major acquisitions in 2021 and 2022 that are driving our future growth today. For these five reasons, we see great opportunity for growth over the coming years. Yet current market conditions require action. And as Greg will outline in a moment, we have cut costs to improve profitability. We cut expenses, eliminated significant discretionary spending, and are not backfilling positions. And because our 2022 performance fell shy of our annual budget, we did not fully fund our bonus pool. We funded the general employee bonus pool at the highest level possible, taking into account inflationary pressures and the tight labor markets, and cut the senior executive bonus pool dramatically to accomplish this. The senior executive team was eligible for 50% bonuses due to meeting targets such as adjusted EBITDA. It only received 25% bonuses to add funding to the general pool. As I said at the beginning, our 2022 performance was unacceptable and the senior management team is responsible and accountable for it. While the capital markets continue to evolve daily with our team in place and expectations for a more stable market in the second half of 2023, we are confident we can meet our 2023 financial goals and return to the growth that WND investors have come to expect from us. I will now turn the call over to Greg to discuss our Q4 and full year financial performance, along with 2023 guidance, and then I'll come back with how we plan to execute in 2023 and beyond. Greg?

Thank you, Willie, and good morning, everyone. Our $11.2 billion of fourth quarter transaction volume generated total revenues of $283 million, down 31% from the same quarter last year, and diluted earnings per share of $1.24, down 49% compared to last year. As a result of the challenging fourth quarter market dynamics Willie just described and the associated impacts on our deal level profitability, our operating margin and return on equity remain below our target ranges at 17% and 10% respectively. We continue to generate durable and growing cash revenues from our servicing and asset management businesses and benefit from the variable nature of our compensation structure when transaction volumes decline. As a result, adjusted EBITDA was $93 million. down only 16% from the same quarter last year, despite a 59% year-over-year decline in total transaction volumes. Notably, recent acquisitions Alliant and Zellman contributed $42 million of revenues this quarter and over $130 million of primarily cash revenues this year, highlighting the stability of those two businesses and the value of those recent investments. We also continue to benefit from earnings on our escrow deposits, which are tied to short-term rates and grew dramatically throughout the year. increasing to $26 million in Q4, up from just $2 million a year ago. Entering 2022, we were confident that our investments in people, brand, and technology, along with a strong and loyal client base and a stable industry environment, would allow us to continue growing revenues, diluted EPS, and adjusted EBITDA by double digits, and deliver a high 20% operating margin and high teams to low 20% return on equity. Our outperformance during the first half of the year supported that confidence. But the unprecedented movements in interest rates and associated impacts on liquidity supplied to commercial real estate brought on a steep decline in transaction volumes and non-cash MSR margins throughout the second half of the year, and we did not meet our targets. Topline results remained healthy, with total transaction volume of $63 billion, down only 7%, and total revenues of $1.3 billion, flat compared to 2021. And we generated $325 million in adjusted EBITDA, up 5% over the prior year. However, diluted earnings per share ended the year at $6.36, down 22% compared to last year, and annual return on equity and operating margin were 13% and 21%, respectively, also below our targets. As commercial real estate transaction activity fell over the last several months, we evaluated our business needs and operating model and made adjustments. During the fourth quarter, we terminated the majority of our temporary employment contracts, stopped backfilling positions, and dramatically reduced growth-related hiring, and as a result, our headcount has steadily declined since October. We also looked closely at discretionary spending and reduced travel and entertainment, terminated several third-party service contracts, and renegotiated a handful of leases across the country. We incurred minimal charges in the fourth quarter in connection with these decisions, and in total, reduced the run rate of personnel and controllable general administrative expenses by more than $15 million. Staying on expenses, I want to spend a few minutes on another adjustment made during the fourth quarter. As a reminder, the acquisitions of GFI and Alliant were structured with earnouts tied to performance milestones. To date, Alliant has achieved $36 million of its $100 million earnout ahead of our expectation, while GFI has not yet achieved any of its $205 million earnout. We are required to revalue our earnout liabilities quarterly, and during the fourth quarter, we recognized a net reduction of $13 million to the other expenses line item associated with these revaluations. The Alliant team continues to perform above our expectations and is well on track to achieving the full earn-out. Affordable housing in this country is front and center, and we feel very good about that acquisition and the integration of Alliant in only our first year together, and we incurred an expense of $5 million associated with the revaluation of this earn-out. With respect to GFI, we align the earn-out milestones with the growth of two emerging businesses, Small Balance Lending and Appraisals. While both businesses grew revenues in 2022, the growth was less than our expectations when we structured the earn-outs because we did not anticipate the economic disruption that began last summer. Therefore, we reduced the carrying value of the GFI earn-out liability by $18 million. We see opportunity for growth in 2023 as we continue to capture market share in the small balance lending and appraisal sectors, and we remain focused on scaling both businesses toward our Drive to 25 objectives, which could also enable GFI to achieve the full value of the earn-out. We will continue to revalue both earn outs periodically and expect to make further evaluation adjustments as we true up actual performance to our estimates over the next several years. In 2022, we introduced segment financial results to provide further insight and transparency into our operating structure and financial performance. As shown on slide 11, our capital market segment, which includes our transaction related businesses, excuse me, includes our transaction related businesses. Transaction volumes for 2022 were down 7% compared to last year. generating $709 million of revenues, down 20%. Revenues declined more steeply than transaction volumes due primarily to tighter servicing fees on new Fannie Mae loans, causing a 33% decline in non-cash MSR revenues. Servicing fee margins on new loans remain below historical levels to start 2023. And although multifamily lending demand remains strong, particularly with the GSEs, liquidity and transaction volumes supporting other asset classes face headwinds in 2023. and we face challenging year-over-year comps the next two quarters. That said, a little more than 60% of compensation costs for this segment are variable, mitigating expected declines in transaction-related revenues. Importantly, we have established a team with a track record of executing for our clients through difficult conditions, and we believe in the long-term outlook of the commercial real estate sector. As Willie stated, this team has captured market share and delivered immense value to our clients through unprecedented volatility. We will continue making investments to keep this team intact and remain focused on achieving our long-term drive to 25 objectives of $65 billion of debt financing volumes and $25 billion of property sales volume. Our SAM segment includes the performance of our servicing activities and asset management businesses. Turning to slide 11, we ended the quarter, slide 12, we ended the quarter with 123 billion, a $123 billion servicing portfolio, $17 billion of assets under management, and $2.7 billion of escrow balances, generating full-year revenues of $507 million, up 34%. With short-term rates expected to remain high, we will continue to see increases in our escrow and other interest income, which grew from $8 million in 2021 to $51 million in 2022. Given the current rate outlook, we expect to generate between $120 and $130 million of escrow and other interest income in 2023. more than double our interest earnings in 2022. Also included in our SAMS segment is the impact of forecasted losses on our at-risk portfolio, which was a net benefit of $14 million in 2022, as we updated our loss forecast and unwound the remaining pandemic-related reserves. Our at-risk portfolio remains incredibly healthy. We averaged less than one basis point of losses over the last three years. The average debt service coverage ratio in our portfolio is over two times and we held only seven basis points of delinquent loans in our portfolio on December 31st. We hold credit exposure exclusively on multifamily loans, and the asset class continues to perform exceptionally well. We will update the historical loss rate used on our loss forecast again in Q1 2023, just as we did in Q1 last year. Our loss forecast will contemplate the economic headwinds we face, but we are also updating the historical loss rate with another year of near zero loan losses. and anticipate recognizing a benefit just as we did a year ago when we updated our loss forecast. Our corporate segment represents the corporate G&A of our business, which includes the majority of our fixed overhead expenses and our corporate debt expense. In 2022, the corporate segment included a one-time gain recognized in the first quarter of $40 million resulting from the GFI acquisition and a tax benefit of $6 million recognized in the third quarter when we restructured our corporate organization chart and repatriated certain assets acquired from GFI. These two items generated over $1 of diluted EPS and will not be repeated in 2023. One of the primary drivers of expenses within the corporate segment is interest expense on our corporate debt, and this quarter we updated our segment reporting to allocate corporate debt expense to provide a better reflection of the performance of each segment. This year, interest expense totaled $34 million, up $8 million in 2021, up from $8 million in 2021 due to an increase in debt to support our acquisition of Alliant and the dramatic increases in short-term rates over the last year. In January, we increased the size of our term loan by $200 million to $795 million and used $116 million of the proceeds to pay down debt assumed in the Alliant acquisition. A slightly higher debt balance and a full year of higher short-term rates will result in continued growth in interest expense in 2023. However, we raised roughly $80 million of strategic capital from the debt upsides and eliminated roughly $25 million in mandatory annual principal paydowns by paying off the Alliant debt, creating greater capital flexibility. Importantly, as shown on slide 13, our debt to adjusted EBITDA ratio at December 31st was 2.2 times, and the $120 to $130 million of escrow and other interest income expected from our escrow balances in 2023 more than offsets the increased cost of borrowing. As we look ahead to 2023, we don't have a crystal ball. but we are planning for short-term rates to remain at or above current levels all year. Consequently, we are managing our business with the expectation that transaction activity in the first half of this year will be slower than the same period last year, but return to growth in the second half of the year. We are planning for servicing fees on new Fannie Mae lending to remain below historical levels until late in 2023. Under this scenario, we expect diluted EPS to be flat in 2023 as the one-time acquisition-related revenues I mentioned earlier are replaced with higher cash-driven servicing and escrow revenues. That, in turn, will drive our ability to deliver double-digit growth in adjusted EBITDA this year. We also expect operating margins to remain in the low 20% range and ROE to remain in the low teens until transaction activity and servicing fees on new loans normalize. As we integrated recent acquisitions this year and dealt with the impacts of an unprecedented evolving macroeconomic environment, we felt that the core performance of Walker and Dunlop's business model was being overshadowed. Therefore, we are introducing a new metric called adjusted core EPS, which better reflects the operating performance of our business by eliminating large swings that can occur from non-cash MSR revenues and expenses and one-time acquisition-related revenues and earn-out revaluation adjustments. As shown on slide 15, adjusted core EPS eliminates differences between actual and estimated credit losses, removes the impacts of both amortization and depreciation and non-cash MSR revenues, and removes the impact of burnout and other acquisition-related revenues and expenses. Also included on the slide is a look back at the trend in adjusted core EPS over the last three years. Although adjusted core EPS fell just over 10% in 2022, that decline was largely driven by the overall decline in transaction volumes and related revenues. For 2023, we expect to grow adjusted core EPS by double digits, largely on the continued growth in servicing, asset management, and escrow-related revenues. will continue to share updates and guidance on this metric in the coming quarters and years as we think it provides investors with a transparent view into the overall health of our business turning briefly to capital allocation in 2023 we ended the year with 226 million dollars of cash before closing our debt refinance in january our cash always decreases seasonally in the first quarter as we pay annual subjective and performance related bonuses and settle our annual tax liabilities our business will continue to generate strong cash flow in 2023 and we have the financial flexibility to prioritize investing capital back into the business closely with returning capital to shareholders. Yesterday, our board of directors approved a quarterly dividend of 63 cents per share, a 5% increase, and authorized the $75 million share repurchase program. This is our fifth annual dividend increase since we initiated the dividend in February 2018 at 25 cents per share and represents a cumulative increase of 152% over the last five years. Our outlook for 2023 and expected double-digit growth in adjusted EBITDA gives us confidence to increase the dividend yet again while still retaining capital to support the business. We entered 2023 with conviction that we have the right team in place and a brand that continues to gain market share. We are focused on leveraging technology to create operating efficiencies and scale emerging businesses for the long term. We also have an experienced management team that has dealt with market disruptions and recessions and not only prevailed but grown. Our business model is diversified due to the strategic investments we made over the past few years and durable due to our servicing portfolio that has steadily grown over time. Close cost management combined with our steady cash flow generation will allow us to weather the current storm and emerge poised for growth. Most importantly, we remain focused on investing in our business to achieve our long-term Drive to 25 objectives and delivering returns for our shareholders. Thank you for joining us this morning and for your continued confidence in Walker & Dunlop. I'll now turn the call back over to Willie.