Walker & Dunlop (WD 1.40%) crushed it in 2020. Despite the hardships posed by COVID-19, the actions taken by the Federal Reserve in response to the coronavirus pandemic rippled across the economy in ways that benefited the commercial real estate financing specialist.
With benchmark interest rates at historic lows, mortgages dropped to their lowest rates in 50 years. This inspired a record number of mortgage originations; back in November, analytics firm Black Knight forecast that in 2020, the value of mortgage originations was likely to break $4 trillion for the first time ever. Other trends, such as the surge in people moving from larger metropolitan areas to suburbs, smaller towns, and rural areas, have also helped boost the mortgage industry.
But out of this whole group, Walker & Dunlop stands out to me because of its focus on multifamily properties. While some of the tailwinds that have been propelling the broader mortgage finance industry could fade in 2021, this lender's strategic focus has positioned it for continued success.
Tremendous growth
In 2015, the management team at Walker & Dunlop laid out its Vision 2020 plan, whose goals included $1 billion in annual revenue by 2020. On one hand, the goal was lofty -- the company's annual revenue was $468 million at the time. But on the other, it was within reach -- Walker & Dunlop was a fast-growing company whose 30%-plus compound annual growth rate over the previous five years was twice the rate needed for the job.
It worked. In 2020, Walker & Dunlop posted revenue of $1.08 billion. During the intervening years, the company has shown stellar compound annual growth rates in both its debt financing volume and in its servicing portfolio -- 16% and 17%, respectively. This boosted its diluted earnings at a 24% annualized rate to $7.69 per share.
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Multifamily lending is its competitive advantage
Walker & Dunlop originates and sells loans through government agencies such as Fannie Mae, Freddie Mac, and the Department of Housing and Urban Development. Its clients includes developers of multifamily properties and other commercial real estate owners.
The company's revenue comes mainly from loan originations and loan servicing. Its originations revenue, which made up roughly 33% of last year's total, comes from loans on new properties or on refinanced loans. Its loan servicing revenue encompasses the fees associated with the ongoing collection of these loan payments. This represents a steady stream of income and made up roughly 55% of the company's total revenue last year.
In the single-family mortgage space, refinancings were done at an unbelievable scale last year, driving record origination numbers for companies like PennyMac Financial Services and Mr. Cooper Group. While this made 2020 a year for the record books, new origination volumes in the single-family space will not likely maintain in the same pace.
In the multifamily mortgage segment, refinancings are less common due to prepayment protections on loans sold or refinanced prior to maturity. The reason for this is that lenders make money off the interest payments on loans. If a borrower were to pay down a significant portion of the loan balance, the lender loses out on those interest payments. Loan prepayment penalties help protect lenders against the loss of future interest income they would've received over time. For this reason, refinancings in the multifamily space tend to be limited.
Because 89% of its servicing portfolio is prepayment-protected, between loan originations and loan servicing, Walker & Dunlop has a competitive advantage that will give it a huge refinancing opportunity in the years ahead. In the company's latest earnings release, CEO Willy Walker reiterated that the upcoming "wave of maturities" will drive lending growth opportunities. Although these loans are prepayment-protected, once they mature, they will create a huge refinancing opportunity.
Source: Walker & Dunlop Investor Day Presentation
In addition, while a lot of lenders refinanced loans on their own books, 66% of Walker & Dunlop's refinancing volume was in new loans. And with the Federal Reserve planning to hold benchmark interest rates at the current rock-bottom levels until at least 2023, there should be plenty of refinancing candidates in the multifamily space looking to lock in better rates.
Not only that, but the company's mortgage servicing rights have a fair value of $1.1 billion, which represents future cash flows it will receive. Its total servicing portfolio is up to $107 billion, a 15% gain from last year, which boosted cash servicing fees by 10% from the prior year, thanks to strong volumes and a sizable increase in the average servicing fee.
And if the economic situation shifts in a way that requires the Fed to boost interest rates sooner than 2023, these servicing rights will provide an important element of stability to Walker & Dunlop's earnings.
Eyes on the prize
Walker & Dunlop has set new goals for 2025, and one is to become the biggest multifamily lender in the U.S. That's well within its reach. In 2019, it ranked No. 6 in its space, behind megabanks such as JPMorgan Chase and Wells Fargo. The company currently projects that when the 2020 rankings come out, it will be in the top three alongside CBRE Group and JPMorgan.
Regardless of where it ranks five years from now among its peers, the ongoing tailwinds from historically low interest rates will benefit the company, driving a wave of refinancings in the multifamily sector. That should make Walker & Dunlop a stock that any investor would love to have in their portfolio.
