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Why Walker & Dunlop Isn't Scared of the Fed

By Dan Caplinger - May 2, 2018 at 7:40PM

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Get the scoop on how the real estate financier is fighting back against higher rates.

The real estate market is facing a potential inflection point right now, and investors in Walker & Dunlop (WD 1.86%) need to be ready to handle shifting market conditions. On the one hand, commercial real estate markets still look strong, and demand for rental properties has also put multifamily properties at a premium. Yet rising interest rates from the Federal Reserve have reduced the amount of loan origination activity in some quarters, and that has the potential to put pressure on companies that benefit from that activity.

Coming into Wednesday's first-quarter financial report, Walker & Dunlop investors were prepared for slight declines in earnings and revenue in anticipation of a potential market turn. The real estate financing specialist did indeed see some pressure on its financial results, but it still remains encouraged by the strategic moves it has made to protect itself from any downturn stemming from rising rates.

Five commercial and multifamily properties with Walker & Dunlop information at the bottom.

Image source: Walker & Dunlop.

The challenges Walker & Dunlop faces

Walker & Dunlop's first-quarter results show the impact that recent market turbulence has had in its industry. Total revenue was down 7% to $147.5 million, faring far worse than the 2% decline that most of those following the stock were expecting to see. Net income was down 15% to $36.9 million, but the resulting earnings of $1.16 per share were still well above the consensus forecast for $1.07 per share.

The speed with which the fundamentals of Walker & Dunlop's industry apparently turned downward was stunning. Total loan origination volume was down 5% to $4.51 billion, with a huge drop in Fannie Mae loans pulling down the entire business despite healthy growth from brokered loans, as well as financing through Freddie Mac and Ginnie Mae. Yet one thing to remember is that Walker & Dunlop had a pair of huge portfolios originated through Fannie Mae in the year-ago quarter, making the comparison particularly difficult. A new portfolio origination of Freddie Mac loans helped to make up for that shortfall. Revenue from loan origination fees came in down 4% from year-ago levels, but gains attributable to mortgage servicing rights plunged from year-ago levels, creating the biggest drag on overall revenue.

What Walker & Dunlop is counting on, though, is that the company's mortgage servicing portfolio can help pick up the slack if rising rates cause further problems in loan originations. The company expanded the size of its servicing portfolio by 18% to nearly $76 billion, with large gains in every major segment of the servicing business. Especially important were Fannie Mae and Freddie Mac, which together represented more than $10 billion in additional servicing assets. With prepayments coming nearly to a standstill, the ability to keep servicing loans should act as a counterbalance against falling demand for new loans in a rising-rate environment. Servicing fee revenue rose 6%, helping to limit the drop in the company's top line overall.

How can Walker & Dunlop keep moving forward?

CEO Willy Walker was happy about how the company has positioned itself. "Walker & Dunlop's strong first-quarter results," Walker said, "reflect the scale and diversification we've achieved through strategic investments in the platform over the past several years." The CEO noted that total transaction volume of $4.85 billion was the second-strongest showing for a first-quarter period in the company's history, only falling short of last year's total of $5.01 billion.

In particular, Walker & Dunlop made a foray into the asset management business by acquiring JCR Capital in April. The alternative asset manager has experience in middle-market commercial real estate investments in debt, preferred equity, and other financing methods. Walker & Dunlop hopes to build that part of its operations into an $8 billion to $10 billion asset management business, while at the same time bulking up its workforce to find opportunities across the industry.

Investors weren't entirely comfortable with the declines that Walker & Dunlop experienced despite its explanations, and the stock fell 5% on Thursday following the morning announcement. Yet even if rates continue to rise, it looks like Walker & Dunlop has put itself in as good a position as possible to minimize any collateral damage on its overall portfolio.

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