Walker & Dunlop, Inc

Good morning, everyone. I'm Kelsey Duffy, Senior Vice President of Investor Relations at Walker & Dunlop, and I'd like to welcome you to Walker & Dunlop's first quarter 2023 earnings conference call and webcast. Hosting the call today is Willie Walker, Walker & Dunlop Chairman and CEO. He's joined by Greg Gorkowski, Executive Vice President and Chief Financial Officer. Today's webcast is being recorded and a replay will be available via webcast on the investor relations section of our website. At this time, all participants have been placed in a listen-only mode and the line will be open for your questions following the presentation. If you have dialed into the call and would like to ask a question at that time, please press star 9 on your phone. If you are accessing the webcast on your computer, please click the raise hand icon in the bottom menu bar of the webcast screen. This morning, we posted our earnings release and presentation to the investor relations section of our website, www.walkertonlaw.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. Walker & Delos business and the broader commercial real estate industry face continued pressure from uncertainty around interest rates and volatile market conditions during the first quarter of 2023. Our financial results reflect the challenges of the current market environment. And while working closely with our clients, our team closed $6.7 billion of total transaction volume, down 47% year over year. Our multifamily property sales volume of $1.9 billion was down 46% year-over-year, compared to 74% decline in the broader market, as reported by CoStar. It's important to note, as we review quarter-over-quarter numbers, that the Federal Reserve began its tightening cycle at the very end of Q1 2022, making it the final quarter of the post-pandemic easy money cycle. Q1 total revenue was $239 million, down 25%, and diluted earnings per share were 79 cents, down 63% from Q1 of 2022. Please remember that that Q1 2022 number included a one-time gain triggered by the GeoFi acquisition that contributed 92 cents to our EPS of $2.12. Yet despite dramatically lower transaction volumes due to market conditions, along with revenues and EPS, our adjusted core EPS, a metric we introduced last quarter that strips out large non-cash revenues and expenses to give investors better insight into our current income statement, was up 10% versus Q1 2022, and adjusted EBITDA was up 9% to $68 million. I want to underscore this point. In a quarter where transaction volumes were down 47% from the previous year, we grew adjusted core EPS by 10% and adjusted EBITDA by 9%, thanks to our servicing and asset management businesses that generate significant and consistent revenues. Due to dramatically lower transaction volumes across the industry and at Walker & Dunlop, in mid-April, we realized we right-sized our business and reduced headcount by 110 employees, or 8%. With this action and other cost-cutting measures that Greg will outline in a moment, we have significantly reduced operating expenses to a level where we can withstand transaction volumes similar to Q1 for the rest of 2023. That is clearly not our hope. And as I will outline in a moment, we see plenty of potential upside. But for now, we had to take the hard step of right-sizing our company and saying goodbye to a group of valuable colleagues who contributed a great deal to our past success. We remain focused on achieving our Drive to 25 business plan, which has always been highly ambitious, even before the current market dislocation. Yet Walker & Dunlop established its first five-year stretch business plan in 2007. And when the great financial crisis hit, every indicator told us the five-year plan was off the table. Yet we remained focused, grew our counter-cyclical lending relationships with Fannie Mae, Freddie Mac, and HUD, and achieved every element of our five-year plan in 2012. We see a similar opportunity today. by focusing on operational excellence and cost containment, and then leaping forward as the market heals. Where is there potential upside? The recent banking crisis pulled banks out of the commercial real estate lending market almost immediately. Fannie Mae and Freddie Mac's multifamily lending volumes have increased significantly since then. And should these volumes be sustained throughout the year, as the largest GSE lender in the country in 2022, WND's GSE volumes will be significantly higher than what we are currently forecasting. Banks pulling back from commercial real estate lending in an effort to build more liquid balance sheets has broader implications than just increasing GSE lending. Nearly 40% of the $4.5 trillion of total commercial mortgage debt outstanding today sits on bank balance sheets. If banks pull back 5% to 10% in commercial real estate lending, it could create the need for $225 to $450 billion of new capital from life insurance companies, CMBS securitizations, or private debt funds raised by registered investment advisors like Walker & Dunlop. Not only does Walker & Dunlop have the fund management business to raise and manage this type of capital, but we also have the distribution network with over 220 bankers and brokers across the country to deploy it. In addition to the capital raising opportunities that the bank pullback presents, there is also a long-term growth opportunity for our debt brokerage business. Banks have direct relationships with their commercial real estate customers, which means that a significant portion of the $1.7 trillion of commercial real estate loans on bank balance sheets today was originated without a mortgage broker. The role of our debt brokers becomes more important than ever in a capital-constrained market, as borrowers need a broker's expertise to look broadly across the market for the most competitive capital source. In the short term, there is no doubt that a lack of liquidity to the broader market will put pressure on our debt brokerage business. But over time, these opportunities could be a significant driver of growth in our brokered volumes. There's plenty of concern about commercial real estate exposure on bank balance sheets, particularly as it relates to office loans. Walker & Dunlop has zero credit risk on any office loan or any asset class outside of multifamily. Our at-risk multifamily servicing portfolio continues to be exceedingly healthy, as evidenced by the benefit for credit losses we recognized in Q1. From our experience, it would take a dramatic increase in the unemployment rate to impact multifamily fundamentals broadly. The unemployment rate today sits at 3.5%. And while the Federal Reserve is trying to cool employment and raise unemployment to 5.5%, Even that elevated level is dramatically below the 9.5% unemployment rate reached in 2009 during the great financial crisis. After 9.5% unemployment in 2009, Walker & Dunlop's at-risk portfolio reached 1.64% of loans 60 days delinquent in Q2 of 2010. And as the economy healed in 2010 and 2011, loans got current and the total losses to our portfolio after the great financial crisis and 9.5% unemployment was a cumulative 16 basis points. This is not to say there will not be multifamily loan defaults. We are already seeing defaults in other lenders' portfolios on poorly acquired and financed properties from the past several years. But given current employment levels and the ability for the Fed to start cutting rates should the economy falter, we are currently not concerned about broad credit losses in our multifamily portfolio. Housing affordability is a real concern, as the average entry-level monthly payments for an existing home increased 32% in 2022, nearly tripling the prior record increase of 13% in 2013, according to Zellman & Associates. Stretched affordability has been fueled by 2022 sharp rise in mortgage rates on top of recent years home price growth, challenging future home ownership, likely keeping residents in rental housing longer. Walker and Dunlop's acquisition of Alliant, one of the largest affordable housing owners and tax credit syndicators in the nation at the end of 2021 was very well-timed. Alliant's financial performance is terrific and WND's capabilities and brand in the affordable housing industry are greatly enhanced due to Alliant. Zellman is another recent acquisition that has performed exceedingly well. Zellman's research on all sectors of housing continues to grow its subscription base and make Walker & Dunlop increasingly insightful on single-family, build-for-rent, and multifamily. And as Greg will detail in a moment, Zellman's investment banking division had a strong Q1 and sets WND up well to expand our investment banking capabilities into the commercial market in the next cycle. Finally, we continue to integrate the technology we acquired with Geofi into our appraisals and small balance lending businesses. As transaction volumes have fallen, so has the need for appraisals. So a prize is behind for 2023, as is our small balance lending business. Yet banks pulling back from commercial real estate lending has a dramatic impact on the small balance space. Banks dominate the small multifamily lending space, and any pullback presents a significant opportunity for Walker & Dunlop's small balance lending business. I'll now turn the call over to Greg to discuss our Q1 financial performance and 2023 financial outlook in detail, and then I'll come back with some thoughts about what we see ahead. Greg?

Thank you, Willie, and good morning, everyone. As Willie discussed, challenging conditions in the commercial real estate market persisted into 2023, putting pressure on our first quarter transaction volumes, revenues, and earnings. Diluted EPS was 79 cents per share, down from $2.12 per share in the year-ago quarter. As a reminder, the first quarter of 2022 included a $40 million benefit due to the revaluation of our appraisal business upon closing the acquisition of GFI. This boosted total revenues and added 92 cents per share to diluted EPS in the year-ago quarter. Importantly, adjusted core EPS, which eliminates the large swings that can occur from non-cash revenues and expenses and acquisition-related activity, grew to $1.17 per share this quarter, up 10% over last year. As we have consistently seen through the volatility over the last year, our servicing and asset management businesses continue to generate durable and growing cash revenues, which in combination with our variable expense structure has enabled us to consistently generate healthy adjusted EBITDA. Our escrow and interest earnings have also benefited from the rapid increase in interest rates over the last 12 months and offset some of the declines in transaction volumes. As a result, despite transaction volumes declining 47%, our Q1 adjusted EBITDA was $68 million, growing 9%. Adjusted EBITDA also benefited from the performance of Alliant and Zellman, which contributed $33 million of primarily cash revenues during the quarter. Notably, Zellman closed the largest investment banking transaction in its history this quarter, providing an attractive upside to the consistent subscription revenue streams that come with its research business. We remain focused on adding multifamily investment banking capabilities to complement Zellman's existing single family expertise so that we will be well positioned to take advantage of M&A and other capital markets transactions that arise as the commercial real estate transaction market recovers. Our first quarter operating margin was 14% and return on equity was 6%, both below our target ranges, but not unexpected given the decline in transaction activity. For the past several quarters, we have been focused on reducing expenses to maximize our operating margins. And in mid April, we reduced our head count by over 100 employees in reaction to lower than anticipated volumes and continued uncertainty in the commercial real estate transaction market. As a result of this reduction, we will incur a $3 million expense and expect the savings from the action to largely offset that charge in the second quarter of 2023 with the full benefit of the savings realized in the third and fourth quarters. As a result of the cost cutting we have implemented, we eliminated $15 million of annual controllable GNA costs coming into this year and reduced annual personnel related costs by $25 million after the headcount reduction in April. These were necessary steps to improve our operating leverage in response to a challenging and evolving commercial real estate services landscape. Turning now to slide six in our three segments. Total revenues for our capital market segment, which includes our transaction-related businesses, were down 38% to $104 million, driven almost entirely by the 47% decline in transaction volumes. The supply of capital to the commercial real estate market remains constrained, and our first quarter debt brokered originations were affected most, declining 58% to $2.4 billion. Until capital begins to confidently flow again, our brokered volumes will remain impacted. A lack of liquidity and higher interest rates is also putting downward pressure on commercial real estate asset values and causing clients that would otherwise be sellers to hold on to their assets. Our Q1 property sales volumes outperformed the market, but still declined 46% to $1.9 billion. Agency volumes of $2.5 billion were also slow this quarter, but Fannie Mae, Freddie Mac, and HUD have a real opportunity to supply significant counter-cyclical capital while liquidity remains constrained, and we are very well positioned as their largest partner. The sharp decline in transaction activity during the first quarter impacted the financial performance of the segment, which can be seen in the year-over-year declines in adjusted EBITDA and earnings. The first quarter is traditionally a slower quarter of activity for this segment, and the macroeconomic challenges we are facing slowed it down even further. Adjusted EBITDA and earnings for our capital market segment will improve as capital and confidence return to the commercial real estate market. And more than ever before, our clients are drawing on the expertise of bankers and brokers to navigate the challenging market conditions and our team continues to deliver significant value on every transaction that crosses the finish line. The servicing and asset management, or SAM segment, includes our servicing activities and asset management business, both of which produce stable, recurring revenue streams. As a result, this segment is largely insulated from the transaction-related volatility reflected in the financial results of our capital markets segment. SAM revenues increased 25% year-over-year to $133 million due to growth in servicing fees and escrow earnings. Also included in our SAM segment is the impact of forecasted losses on our at-risk portfolio. We are in the process of collecting year-end financial statements for all of our loans, and although that process is ongoing, the weighted average debt service coverage ratio remains above two times thus far. Importantly, the book continues to perform exceptionally well, and we have only seven basis points of defaulted loans in the at-risk portfolio at March 31st. During the first quarter, we performed our annual update to the CESA loss factor, a 10-year look back at our historical losses that is used in our loan loss reserve calculation. We updated the calculation with 2023 data, a year of near zero losses, and the loss factor declined from 1.2 basis points to 0.6 basis points, as a year with relatively few higher losses fell out of the 10-year look back period. Importantly, our methodology also includes a forward-looking adjustment called the forecast period, which takes into account current economic conditions. We continue to apply an upward adjustment to the forecast period, currently four times greater than our historical loss factor, to reflect the challenging macroeconomic conditions, which partially offset the overall reduction to our allowance from updating the historical loss factor. The update to our CECL methodology combined with the exceptionally strong credit fundamentals underpinning our at-risk portfolio resulted in a net benefit of $11 million in the first quarter of 2023, compared to a benefit of $9.4 million in Q1 last year. Our corporate segment represents the corporate G&A of our business, which includes the majority of our fixed overhead expenses and an allocation of our corporate debt expense. In the first quarter of 2022, other revenues for this segment included the one-time $40 million gain resulting from the GFI acquisition, causing the majority of the decline in total revenues for this segment. On a consolidated basis, interest expense on corporate debt totaled $15.3 million, in line with the annual estimate of 50 million to 60 million that we gave on our last earnings call. Neither of those items impact adjusted EBITDA for this segment. So the $6 million improvement in adjusted EBITDA is driven partially by the cost-saving measures we put in place two quarters ago and partially by an improvement in interest earnings on our corporate cash balances and pledge security portfolio. Forecasting transaction activity within today's rapidly changing market is extremely difficult. Higher rates and constrained liquidity continue to impact our business and commercial real estate transaction activity. We do not have clarity on whether markets will recover in the back half of the year, so we are revising our guidance for 2023, as shown on slide nine, to provide a range for our key financial metrics. The low end of our range reflects Q1 macroeconomic conditions persisting, causing debt brokerage and property sales transaction volumes to remain near Q1 levels for the rest of the year. This downside scenario would result in a 35% year over year decline in diluted EPS, an operating margin in the mid-teens, and an ROE in the high single digits. Our servicing and asset management revenues are not impacted by sustained declines in transaction activity and will continue to provide stability to our revenues and overall financial results. As a result, our adjusted EBITDA and adjusted core EPS would decline by no more than 10% year over year in this severe downside scenario. The upper end of our range reflects our original guidance that was based on a stabilization of interest rates and a recovery for the transaction markets in the latter half of the year. The Fed's actions yesterday were certainly a step in that direction, but the timing and extent of a recovery remains uncertain. Our property sales team is outperforming our competitors, and our debt brokerage group will continue to add value for our clients. Importantly, the GSEs are providing liquidity to the multifamily market today, and given the pullback in other capital sources, if these conditions are sustained, the GSEs are likely to lend to their full caps, giving us a path to achieving the upper end of our range. Flat diluted EPS, a low 20% operating margin, a low team's return on equity, and double-digit growth in adjusted EBITDA and adjusted core EPS. Turning to capital allocation, we ended Q1 with $188 million of cash after paying corporate taxes, company bonuses, earn-out installments, and our dividend during the quarter. We not only maintain a strong liquidity position, we are also generating a healthy amount of cash from our core businesses, as reflected by the growth in adjusted EBITDA. Importantly, as historical investments on our balance sheet mature in the coming quarters, such as our interim loan portfolio, we will retain that cash to further strengthen our cash position. We will continue to allocate capital to our shareholders, and yesterday, our board of directors approved a quarterly dividend of 63 cents per share, payable to shareholders of record as of May 18th, consistent with last quarter's dividend. We view the dividend as an important part of our value proposition to investors, and maintaining the dividend at its current level reflects our confidence in our business model and our ability to manage through the current conditions impacting the commercial real estate sector. One month into the second quarter of 2023, the commercial real estate industry continues to face a challenging rate environment, concerns over credit fundamentals of non-multifamily assets and speculation around the long-term impacts of the banking crisis. Despite all of these unknowns today, we remain focused on our long-term financial and operational goals. We feel very good about the team we have in place, the value we provide to our clients and our ability to manage through the current obstacles to deliver long-term value to our shareholders. Thank you for your time this morning. I will now turn the call back over to Willie.