Earnings Call Transcript - WD Q3 2022

Kelsey Duffey, SVP of Investor Relations

Good morning. I'm Kelsey Duffey, Senior Vice President of Investor Relations at Walker & Dunlop and I would like to welcome you to Walker & Dunlop's Third Quarter 2022 Earnings Conference Call and Webcast. Hosting the call today is Willy Walker, Walker & Dunlop Chairman and CEO. He is joined by Greg Florkowski, Executive Vice President and CFO. Today's webcast is being recorded and a replay will be available via webcast on our Investor Relations section of our website. At this time, all participants have been placed in a listen-only mode, and the line will be for your questions following the presentation. This morning, we posted our earnings release and presentation to the Investor Relations section of our website. These slides serve as a reference point for some of what Willy and Greg will touch on during the call. Please also note that we will reference the non-GAAP financial metrics, adjusted EBITDA and adjusted diluted earnings per share 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 Willy.

Willy Walker, Chairman and CEO

Thank you, Kelsey, and good morning everyone. W&D delivered exceptional service to our clients during a volatile and challenging third quarter. $17 billion of total transaction volume was very strong and is thanks to our people, brand and the use of technology in everything we do. I've been CEO of Walker & Dunlop for 15 years. I've seen a lot, the housing boom and bust, the great financial crisis, dramatic regulatory changes, new administrations, a pandemic. And I've watched this amazing company deal with adversity, adjust and continue growing. W&D shareholders should be confident in three things; number one, our scaled lending partnerships with Fannie Mae, Freddie Mac and HUD provide our clients with much-needed countercyclical capital during times of market dislocation. Number two, our business model, which includes consistent servicing and asset management fees along with escrow income that expands as rates rise has consistently outperformed in down markets. And number three, our disciplined credit culture on loans we originate, as well as our own balance sheet will allow us to expand while others contract over the coming months and years. We have no greater insight than anyone else on how the markets will evolve over the coming quarters, but we are better positioned than any competitor firm in our industry to continue providing solutions to our clients, maintain our exceptional team and continue investing towards our five-year growth plan to drive the $25 billion. $17 billion of total transaction volume in Q3 generated total revenues of $316 million, down only 9% from Q3 of last year. In this rising rate environment, every deal, whether a sale or refinancing is under pricing pressure. Spreads on our agency lending remain compressed as we work closely with Fannie Mae and Freddie Mac to make deals work for our clients. Good news, we closed a lot of financing in Q3. Bad news, we saw a steep decline in our non-cash mortgage servicing rights revenue and net income. This pricing pressure is solely due to interest rate increases and it will abate the moment rates stabilize. To underscore this point in Q3 of last year, the capital markets were flooded with competitors lending at tight spreads and low rates, and our average gain on sale margin was 165 basis points. This year in a quarter when competitors withdrew, our average gain on sale margin was 123 basis points, down 25%. That pricing compression is due to the 10-year treasury jumping over 100 basis points during the quarter and our need to adjust prices to meet our clients' needs. When the Fed stops dramatic rate increases at every meeting, spreads on our agency lending should normalize and our average gain on sale margin will recover. Our scaled and enduring partnerships with Fannie Mae and Freddie Mac provided much-needed countercyclical capital to the multifamily market during the quarter. Year-to-date lending volume with the GSEs is $13 billion. And as you can see on slide 4, $9 billion of volume with Fannie Mae is 17% market share, keeping us on track to be Fannie's largest lending partner once again. Two additional comments on pricing deals to win. First, we added $1.8 billion of loans to our servicing portfolio in Q3 and the average servicing fee increased from 24.6 basis points to 24.7 basis points, as payoffs had lower average servicing fees than the new loans we added. Second, we get paid for our risk via our servicing fees. So, tighter servicing fees would hopefully correspond to lower risk. The weighted average loan to value on the risk-sharing loans we originated in Q3 was 57%, down from 61% last year. We feel extremely good about the loans, credit quality and customer service we delivered in Q3. And as soon as rates stabilize, our servicing fees and capitalized MSRs should revert to historic averages. Cash revenues and earnings continued to grow in Q3. Adjusted EBITDA expanded to $75 million, up 4% year-over-year, while adjusted EPS, which strips out the impact of noncash items, was up 5% to $1.55. These numbers reflect W&D's terrific business model. As banks, debt funds, and CMBS lenders pulled out of the market in Q3, our Capital Markets Group had a surprisingly strong quarter, with $6.6 billion of debt brokerage volume. Similarly, as multifamily sales volumes fell precipitously off 17% according to RCA, our property sales team closed $5 billion of volume, down only 5% from last year. These numbers are truly exceptional in comparison to our competitors' published numbers for Q3 and show the ability of our bankers and brokers to deliver for our clients in challenging markets. We expect to see softening in both of these executions in Q4, but feel very good about our team's ability to continue growing market share in 2023. All of our teams excel for our clients in Q3. According to Bain & Company, the most relevant question to determine customer service is, would you recommend this product or service to a friend? The answer to that question on a scale of negative 100 to positive 100 is your Net Promoter Score. The average Net Promoter Score in the financial services is 44. Walker & Dunlop's Net Promoter Score is 91, over 2x the industry average. And beyond providing exceptional customer service, we continue to use technology to identify and attract new clients to Walker & Dunlop. In Q3, 69% of our refinancings were new loans to Walker & Dunlop and 30% of our total transaction volume was with new clients. Rising rates and economic headwinds may curtail business volumes in the short term, but Walker & Dunlop's service level and use of technology position us exceptionally well to continue to outperform going forward. We built or acquired complementary businesses in affordable housing, research, small balance lending, and appraisals over the past three years. Zelman and Alliant, our two major 2021 acquisitions contributed nearly $30 million in revenues in Q3 and are both on budget for 2022. Hindsight is always 2020 vision, but it speaks volumes about W&D's M&A strategy that our two largest recent acquisitions were not pro-cyclical, such as expanding our bank or brokering operations, but rather enduring consistent business models that perform in good and bad markets. And GeoPhy, the largest technology investment we've ever made, is focused on accelerating the growth of our small balance lending and appraisal businesses. All of these investments get us very excited about W&D's future growth. Our servicing portfolio grew to $121 billion, up 6% over Q3 2021 and generated $76 million of income on the quarter. 89% of the servicing fees in our portfolio are prepayment protected, and as Greg will explain in a moment, the Escrows inside that portfolio earn more and more as rates rise. When the great financial crisis of 2008 and pandemic in 2020 hit, our first concern was credit, would W&D suffer significant loan losses? The answer was no, due to W&D's credit culture and the strength of multifamily as an asset class. Today, as we look at our portfolio and the fundamentals of multifamily, the answer is no, once again. We have an exceedingly clean book. Thanks to our team and credit discipline. We have no credit exposure to office, retail, or other commercial real estate asset classes. We have no credit risk on construction loans. We did not make nor carry credit risk on any CLO loans, and the weighted average debt service coverage ratio in our at-risk servicing portfolio currently sits at 2.32 times. Let me put that into context. Our minimum debt service coverage ratio on new loans is 1.25 times, and the overall portfolio currently sits at 2.32 times. Credit is not a concern. I will now turn the call over to Greg to discuss our Q3 results and financial outlook in more detail, and then I'll come back with thoughts about 2023 and beyond.

Greg Florkowski, Executive Vice President and CFO

Thank you, Willy, and good morning everyone. Our $17 billion of transaction volumes this quarter generated total revenues of $316 million, down 9% from the third quarter of last year, and diluted earnings per share of $1.40, down 37% compared to last year. As a result of the spread and pricing dynamics, Willy just described, our non-cash MSR revenues dropped 38%, despite nearly flat Fannie Mae volumes. The decrease in MSR revenues caused our operating margins and return on equity to fall below our target ranges at 17% and 11%, respectively. Our value proposition includes navigating challenging markets on behalf of our clients and closing the deals that work for them. In this quarter, we were able to deliver for our clients when they needed us most. Importantly, our agency lending grows our servicing portfolio and increases our long-term stable cash revenues, which occurred yet again this quarter, as the servicing portfolio increased to $121 million. As a result, our cash revenues expanded and our adjusted EBITDA grew 4% to $75 million, and drove 5% growth in adjusted earnings per share to $1.55 this quarter. A further benefit of our servicing portfolio is at $3 billion of escrow earnings we hold. Sharp increases in short-term rates disrupted transaction volumes but dramatically increased our escrow earnings. This quarter, escrow earnings increased nearly 800% to $18 million compared to only $2 million in the year-ago quarter. Another contributor to growth in adjusted EBITDA and adjusted EPS is the acquisitions of Alliant and Zelman. On a combined basis, these businesses generated nearly $30 million of primarily cash revenues this quarter, highlighting the benefit of the investments we made in the stable subscription revenues of Zelman, and the assets under management at Alliant. In the first quarter of 2022, we introduced segment financial results to provide more transparency into our operating structure and overall financial performance. As shown on Slide 7, our Capital Markets segment, which drives transaction volumes, generated revenues of $183 million this quarter, down 27% compared to last year. Expenses for the segment fell 8%, largely due to lower variable commissions from lower transaction-related revenues, which helped produce breakeven adjusted EBITDA for the segment this quarter. A little more than 60% of compensation costs are variable for this segment, mitigating expected declines in transaction-related revenues for the rest of this year. We are confident our team will continue to deliver strong GSE and HUD volumes due to the counter-cyclical nature of the capital, but recognize our debt brokerage and property sales teams will face pressure as liquidity from banks and other executions pull back. Our long-term outlook for our capital markets team remains unchanged despite the headwinds, and we will continue making investments to sustain our long-term growth objectives for this segment. Our SAM segment includes the performance of our servicing activities and asset management businesses. As shown on Slide 8, revenues for our SAM segment grew 40% this quarter, or $39 million due to increased servicing fees, escrow earnings, and revenues from Alliant. The growth in revenues generated 69% growth in operating income and 30% growth in adjusted EBITDA. The revenues within our SAM segment are resilient and growing. Our loan servicing portfolio is generating over $300 million of annual recurring revenues and the prepayment protected duration of the portfolio is nearly nine years. Our long-term strategy to grow our assets under management is paying dividends, as our $17 billion of assets under management earned $83 million of revenues year-to-date. Lastly, short-term rates continue to increase and escrow and other interest income will continue to drive growth in cash and adjusted EBITDA. Our Corporate segment represents the corporate G&A of our business and also includes our corporate debt expense. As shown on Slide 9, the net loss for the segment decreased $3.4 million, or 11% this quarter, while adjusted EBITDA increased 3% from the year-ago quarter. A few things to highlight. Total compensation costs were down $10 million as we made downward adjustments to our company bonus and performance-based equity accruals this quarter on our revised outlook for 2022, which I'll explain in a moment. Those downward revisions were offset by a $7.5 million increase in interest expense on our corporate borrowings as our term debt is indexed to SOFR. During the quarter, we also restructured our legal entity organizational change and repatriated the intellectual property acquired from GeoPhy earlier this year. The impact of which was an overall reduction in future tax liabilities of about $6 million, or approximately $0.20 of diluted EPS, which reduced our consolidated annual effective tax rate to 14% this quarter. This was a one-time benefit of the restructuring and our annual effective tax rate will return to its normal level of about 27% next quarter. Year-to-date, total transaction volumes were up 27%, but operating margin and return on equity remained below our target ranges at 22% and 14%, respectively, due largely to the declines in non-cash revenues we began experiencing in the second quarter. Our year-to-date diluted EPS is $5.13, down 10% compared to the same period last year. Year-to-date adjusted EPS is up 10%, reflecting our business' ability to generate cash even as the transaction market slows down. Over the last 90 days, rapid increases in interest rates and fears of a global recession impacted transaction volumes and caused servicing fees on new loans to remain at lower levels. We expect servicing fees on new loans to remain at current levels for at least the rest of 2022, and we do not expect transaction activity for our brokered and investment sales executions to rebound until interest rates stabilize. As shown on slide 10, we are now projecting diluted EPS will be down between 15% and 20% this year. Notably, year-to-date personnel expense as a percentage of revenue is 48%, in line with last year. Our variable costs will adjust downward in line with any decline in transaction revenues in the fourth quarter. And that coupled with the strength of our servicing and asset management revenues gives us confidence that we will deliver growth and adjusted EBITDA in 2022 in the mid to high single digits. We are not making any adjustments to our ROE or operating margin targets but expect to perform at the lower end of the ranges. As we look ahead, we reviewed our operating costs and have been actively reducing expenses based on our outlook for slower transaction volumes next year. These reductions will largely impact our G&A costs and most will not be realized until next year. We are not immediately reducing headcount, but we have significantly curtailed our planned new hires, and are being more selective in backfilling positions. As you can see on slide 11, we operate an efficient business, generating over $900,000 of annualized revenue per employee, at the top of our peer group by a wide margin. Importantly, over half of our compensation costs are variable, causing compensation expense to naturally adjust downward for any declines in transaction revenues. We are in a service business and we believe that our people and culture differentiate us, as reflected in the Net Promoter Score, Willy outlined. We do not intend to disrupt the quality of that service by reducing headcount and we believe our business model and access to counter-cyclical capital allow us to invest in our people to not only continue growing market share in the coming months but take advantage of the opportunity when transaction volumes rebound in 2023. We ended the third quarter with $152 million of cash on the balance sheet in line with the end of Q2. We prioritized investing in the business this quarter and used capital to pay down principal on our outstanding debt, fund co-investments to grow our asset management business, bring on three new property sales teams, and fund obligations under our purchase agreement with Alliant. Given the number of opportunities to invest nearly $50 million back into the business this quarter and our desire to maintain a strong cash balance, we did not repurchase shares. We continue to generate a healthy amount of cash to fund our operations and invest in the business. And yesterday, our Board approved a dividend of $0.60 per share again this quarter, payable to shareholders of record as of November 25, 2022. We will have returned nearly $100 million of capital to shareholders this year through a combination of share repurchases and dividends, and we continue to prioritize this closely with investments in the business. We faced a challenging macro backdrop and several of our operating metrics like diluted EPS, operating margin, and ROE will remain under pressure in the near term due to lower servicing fees on new loans and lower transaction volumes. Our ability to generate cash and growth in adjusted EBITDA is not tied to lower transaction markets. Our servicing portfolio provides over $300 million of annuity-like cash flows. And as shown on slide 12, our escrow earnings are growing and fully hedged against our floating rate debt. As Fed funds have now reached 4%, our escrow earnings will generate between $100 million and $115 million of annualized revenues, more than offsetting increases in floating rate debt expense and providing between $55 million and $70 million of annualized operating income. We also have a healthy balance sheet with $711 million of corporate debt and we continue to maintain a strong cash position. Our corporate debt to adjusted EBITDA has declined from 2.4 times at year-end to just over 2 times today, largely from the continued growth in adjusted EBITDA. We have a resilient and diversified business model that will continue to generate strong cash flow, despite the uncertain macro environment. We remain focused on managing costs to operate an efficient platform while investing in our business to create long-term profitable growth. I will now turn the call back over to Willy.

Willy Walker, Chairman and CEO

Thank you, Greg. Walker & Dunlop's exceptional business model generates strong cash flows in up and down markets. If you look back at our performance coming out of the GFC and pandemic, after initial market overreaction, W&D wildly outperformed the competition due to our access to countercyclical capital, focused business model, and disciplined credit culture. If you look at slide 14 with W&D in dark blue, after getting hit harder in the market sell-off than the S&P, CRE, service providers, and mortgage originators, W&D recovered quickly in 2020 and moved dramatically higher than the market and the competition. This was due to our access to countercyclical capital, which not only provided needed liquidity when the market dislocated, but also in its aftermath when the competitive landscape was deserted. Remember that Walker & Dunlop surpassed JPMorgan and Wells Fargo in 2020 as the largest provider of capital to the multifamily industry. Then fast forward to 2021, when the investments we made in debt and property brokerage rebounded, and you see why the W&D business model is so powerful. And unlike 2021, when the Fed funds rate was at zero, in this higher interest rate environment we will continue generating high-margin revenues on our escrow balances. When I joined Walker & Dunlop in 2003, we had a $6 billion servicing portfolio. Today that portfolio is 20 times bigger at $121 billion. And as Greg just mentioned, it generated $76 million in revenue in Q3. Add to that our asset management business, which is currently making first trust preferred equity and JV equity investments while many competitors sit on the sidelines, and you see the W&D strategy of building long-term durable revenue streams come front and center. And our affordable housing platform Alliant is a market leader in the much needed and focused on area of affordable and workforce housing. Even in this elevated rate environment, with the potential for a recession in 2023, we reiterate our confidence in achieving our five-year drive to 2025 growth plan. Can we get to $65 billion of annualized debt financing? We've done $54 billion of debt financing over the past four quarters. When we get to $25 billion of multifamily investment sales, we've done $26 billion over the last 12 months. A $160 billion servicing portfolio in a higher rate environment, existing loans get stickier and our bankers and brokers have shown time and again how to take market share. The new businesses of small balance lending, appraisals, affordable debt and equity, research and investment banking add significant cash revenues and will accelerate the growth of our scale banking and brokerage businesses. Reaching our revenue target of $2 billion is highly achievable. And while GAAP EPS is pressured in 2022, due to the lower non-cash mortgage servicing rights, a return to normalized servicing fees and MSRs in conjunction with increased escrow, asset management and servicing income will push us over $13 a share by 2025 in our current modeling. Yesterday, we celebrated Walker & Dunlop's 85th anniversary, 85 years since my grandfather and great uncle started this company. We have weathered many economic cycles at W&D. My family has lived through all of those cycles and tried to provide consistent visionary leadership throughout. And as we weather the current economic headwinds, it is very clear that W&D is exceptionally well positioned. I would reiterate the three points I made to open this call. W&D has access to counter-cyclical capital, which will allow us to continue meeting our clients' needs. W&D's business performs in both up and down markets. And our conservative lending and corporate debt structure positions us very well in times of uncertainty and opportunity. Walker & Dunlop's people, brand and technology are world class, and we will continue winning with our clients, with our partners, and for our investors. I will now turn the call over to Kelsey to open the line for questions.

Operator, Operator

The line is now open for questions. Our first question is coming from Jade Rahmani at KBW. Jade?

Willy Walker, Chairman and CEO

Jade, we can't hear you, you are mute. Still nothing, Jade. I think you just came through, Jade. Try now.

Jade Rahmani, Analyst

Thank you very much. Sorry about that. On the transaction volume outlook, quite impressive performance in the quarter. I was wondering if you could give any fourth quarter update on how things are trending. You said you don't expect things to pick up. The Fannie Mae volumes in particular were extremely strong. And also, broker loan volumes were much stronger than some of the performances we've seen elsewhere and they were up 3% year-on-year. Just on those two line items, maybe could you provide any comments?

Willy Walker, Chairman and CEO

Thank you for joining us this morning, Jade. We're not providing specific volume guidance for Q4. As you mentioned, our Q3 volumes were stronger than our competitors, which speaks to our team's relationships and relevance to our clients. Regarding Q4 transaction volumes, there is still significant carryover from Q3, and sales are still occurring. The key issue is the replenishment of the pipeline, which has slowed down considerably. On the capital markets side, many bankers and brokers are currently focused on agency financing. With respect to the agencies, Freddie Mac has entered the market strongly in October and early November, pricing deals competitively and gaining a lot of business recently. However, Freddie Mac will soon reach a point where they can no longer process business for 2022, which may create an opportunity for Fannie Mae to re-enter the market and price deals competitively. Our established relationships with both Fannie and Freddie are very valuable to us, and they are currently dominating the lending market, as they have in the past and are likely to continue into 2023.

Jade Rahmani, Analyst

Thank you very much. And again on the gain on sale margin, that was definitely one of the big variances versus our model. And I think when we met, you were hopeful that there could have been a trough in margins in July thereabouts. Do you still believe that's the case? Could you give any directionality on where you expect gain on sale margins to be headed?

Willy Walker, Chairman and CEO

Yeah, Jade when we did meet here in New York back in the late summer early fall, I did express to you that I was hopeful that we had hit the trough and that things were going to come back out. Quite honestly that inflation print that we saw and the Fed raising by another 75 basis points basically put the pricing situation right back to where it was, because if you think about it, our borrowers, if we quote a deal for them and let's back up a month and we would say that the indicative pricing was going to be a 5.25 coupon rate. And all of a sudden, rates move up by 30 basis points on the base rate on the 10-year treasury. And now all of a sudden we're looking at pricing at 5.50. We've got to work to get back to that 5.25. And so we and Fannie Mae would sit there and look at our GeoPhy and make that type of the deal work. And so that's the type of pricing pressure we are dealing with right now. I would underscore what I said in my prepared remarks, which is just that this is all rate driven. It's not competitive landscape driven. And as a result of that, once we get any type of stabilization from the Fed, I think we will see spreads widen. And I think we will see the ability to price back to normalizing guarantee fees, which will obviously help that noncash mortgage servicing right line item as it relates to both revenues and net income.

Jade Rahmani, Analyst

Thank you very much.

Greg Florkowski, Executive Vice President and CFO

Thanks, Jade.

Operator, Operator

Thank you, Jade. Our next question is from Steve Delaney at JMP. Steve?

Steve Delaney, Analyst

Good morning everyone. Thank you for the question. Willy, it's pretty remarkable that while the topline transaction volume and revenues have decreased, it’s only in the high single digits compared to last year given the circumstances we've faced. It seems your business relies on rates, particularly for customers seeking 10-year fixed-rate loans. Considering our current situation, I suspect that some borrowers are experiencing disrupted business plans. In light of your connection with the agencies, could this be a chance for W&D to enhance your bridge lending offerings, possibly including extension loans? The CLO market isn't completely shut down, but it's close to it, which means that commercial mortgage REITs are unable to participate. You have available capital. Do you see potential in this area over the next two or three quarters? Additionally, Freddie Mac is attempting to revive its Q-series program. Could incorporating that into your strategy help expand short-term lending as high rates diminish the appetite for long-term loans? Thank you.

Willy Walker, Chairman and CEO

Sure, that's a great question. Let me address a few points you've raised. First, I want to emphasize that the volumes we experienced in Q3 highlight the strong relationship we have with Walker & Dunlop and our importance to our customers. While we anticipate a decrease in volumes in Q4, our significance to our clients has never been greater. We are currently working with numerous clients facing challenges with their business plans due to significant changes in interest rates. This has prompted some clients to pursue cash-out refinancing to strengthen their balance sheets, and we are actively engaged in that. Others are deciding to sell their portfolios regardless of current cap rates, leading us to conduct many evaluations for those looking to raise capital and possibly transact. Regarding the CLO market and the Freddie Q series, my understanding is that Freddie is expected to issue approximately $3 billion in Q loans in Q4. For those who may not be familiar, going back to 2007, Freddie Mac bought loans that were essentially stuck on warehouse lines and securitized them, which led to the K series and now the Q series. Some competitors with loans stuck on warehouse lines have been trying to sell those loans into Freddie Mac's Qs. As mentioned earlier, we do not have any CLO loans hanging and have no credit risk associated with them. However, we do hold a number of loans on our balance sheet, including those in our joint venture with Blackstone. The Q execution could potentially provide additional liquidity for us. As Greg noted, we are focused on returning capital to our shareholders through dividends while also maintaining cash reserves to seize any M&A opportunities that may arise or to support key clients who may require our assistance. We have a proven track record of stepping in to support some of our largest client partnerships, and we will do so whenever necessary.

Steve Delaney, Analyst

Your last comment is directly related to my second question regarding these challenging markets, which often result in some corporate casualties. While we are not hoping for that, which area of your business are you most interested in growing opportunistically over the next year during this period of transition and shakeout?

Willy Walker, Chairman and CEO

I want to emphasize that we did not make pro-cyclical acquisitions in 2020 and 2021. This was discussed at our Board meeting yesterday, and it speaks volumes about how both Alliant and Zelman are on track for 2022. We refrained from acquiring a large investment sales business that saw its volumes drop significantly. Similarly, we did not purchase a mortgage brokerage firm given the sharp decline in volumes. I am very pleased with our M&A discipline. In the past, we have been opportunistic, as seen with our acquisition of CW Capital in 2012 after the financial crisis, and we will continue to look for such opportunities when the market fluctuates. Other firms may not perform as well as we do due to our consistent revenue streams and earnings. However, it is important to note that while we have made smaller tuck-in acquisitions in mortgage brokerage and property sales, we haven't pursued a major acquisition since CW in 2012. Many are aware that the JLL/HFF merger was particularly problematic in terms of managing human resources and retaining talent at both firms. While it was beneficial for JLL in terms of product sales, merging those two large companies proved to be a significant challenge. Therefore, we are cautious about engaging in any large-scale acquisitions that are intensive on human capital. Additionally, our culture at Walker & Dunlop is unique, and a large-scale transaction could expose us to cultural shifts that are difficult to manage in a people-oriented business. This does not mean we will never consider a large-scale human capital deal, but it is not currently a priority.

Steve Delaney, Analyst

Understand. And thank you for the comments, Willy, we’ll miss you at our conference next week. But I know that Sheri Thompson will do a great job representing W&D on our affordable housing panel. Thanks.

Greg Florkowski, Executive Vice President and CFO

Thanks, Steve.

Willy Walker, Chairman and CEO

Thanks, Steve.

Operator, Operator

Thank you, Steve. Our next question comes from Henry Coffey of Wedbush Securities. Henry?

Henry Coffey, Analyst

Good morning, everyone. Thank you for taking my question. It seems that on one side, your customers are pulling back significantly. Yet, anyone visiting major metro areas does not observe signs of a recession. How much of this perception is due to customers feeling overwhelmed by the rapid changes in interest rates and confusion surrounding the election? I've heard that Watson Trace may attempt to run again. Additionally, how much of this situation stems from actual changes in the multifamily lending market, such as rent rates or the feasibility of building new properties? Is this primarily related to capital markets, or are there genuine shifts occurring in the multifamily sector from your viewpoint?

Willy Walker, Chairman and CEO

So, Henry, it's great to have you here this morning. Let me share a couple of observations that hopefully will address your question. Firstly, as interest rates have shifted quickly, cap rates haven't fully adjusted. I've heard Jade ask about how some competitors are managing to buy properties with negative leverage. In August and September, there were many buyers willing to accept negative leverage by purchasing at a 4.25% cap rate while taking on 5% debt. However, currently, in October and November, fewer individuals feel comfortable engaging in negative leverage transactions due to the lack of clarity regarding future rate movements. This uncertainty has contributed to decreased transaction volumes. On the other hand, I've talked to three clients recently who expressed frustration, feeling that there's nothing happening in the market, but one of them mentioned they acquired two assets last month. We're currently working on significant refinancing for a client who wants to increase their cash reserves. Additionally, we received an inquiry about selling a nearly $1 billion multifamily portfolio. While many may believe the market is stagnant, I recently urged all Walker & Dunlop salespeople to seize this opportunity while others are on the sidelines. I received numerous responses from bankers and brokers saying they are busier than ever. The question becomes whether this busyness translates into revenue, as every client wants to engage with us regarding property valuations and refinancing options. Interestingly, many borrowers expect rates to decline. We've provided fixed rate quotes recently that are in the low 6s, whereas just a month ago, we offered quotes in the mid-5s. Several clients opted for floating rate debt, believing it's not wise to lock in mid-5s fixed rates for long terms when they anticipate rates will drop. Personally, I would have chosen to lock the rate in and focus on cap rates and rent growth, but that’s just my perspective. The key point, Henry, is that it's a changing market, and there’s a strong belief that rates will begin to decrease in the latter half of 2023. At Walker & Dunlop, we only need rates to stabilize to revive transaction volumes. We don’t require a lower rate environment to see activity pick up. We have counter-cyclical capital available, which allows us to continue lending, and once we achieve some stability, our mortgage servicing rights will normalize, leading to consistent income and net earnings.

Greg Florkowski, Executive Vice President and CFO

And I'll just – I'll add on there too. Beyond multi, we are seeing plenty of activity on the non-multi asset classes as well and rate stabilization brings capital back into the markets and we should see our volumes rebound there as soon as you get stabilization. So there's opportunity across the landscape.

Henry Coffey, Analyst

I think everybody listening to the call was there any history that you understand that W&D is going to be just fine. You plan your business, you plan your balance sheet, etc. What I'm really wondering about is if we put aside all the capital markets funding stuff, we just think of the whole business. If we put that aside and look at your clients, how are they bearing in terms of the operating profitability of their properties? We've seen home price appreciation go down in the residential market since June. Obviously, a lot of that's rate-related. What about the fundamentals of their business? You all have a unique perspective on exactly that, not only in terms of what people want to do with their balance sheets but exactly how the properties are performing. And so push all the noise aside, what does it look like?

Willy Walker, Chairman and CEO

Yes, everyone who owns properties today is enjoying great returns. Those who financed their assets in the past 10 years are experiencing exceptional performance and cash flow. While reports indicate that rent growth has decreased from its peak in 2021 and early 2022, there is still strong cash flow to support refinancing in a higher interest rate environment, especially given the current debt service coverage ratio of 2.32 times in our servicing portfolio. Some may face challenges if they took on floating-rate loans without caps earlier in 2022, but overall, as Peter Linneman noted on our recent webcast, there will be some pain, but also opportunities, albeit limited. Currently, we are seeing a market adjustment with many individuals adopting a wait-and-see approach regarding interest and cap rates, though some are capitalizing on market disruptions. Some will need to sell assets, potentially at distressed prices, and there will be buyers ready to seize those opportunities. Additionally, major banks like JPMorgan, Wells Fargo, and Bank of America have paused lending but are likely to re-enter the market in 2023, given their strong capital positions and significant loan loss reserves. This rebound could greatly enhance liquidity in the commercial real estate sector. As it stands, access to debt capital is primarily through agencies and select life insurance companies, with limited options in the CLO and CMBS markets. Looking ahead, if inflation begins to ease and we receive favorable forecasts on Fed rate hikes, we could see market stabilization and increased transaction volume in the first quarter, which is an optimistic scenario. Many competitors have projected a strong second half of 2023, which seems like a reasonable assessment, but we need to monitor the situation closely in Q2 2023. For Walker & Dunlop, the key question is how long the market remains dislocated, providing us with an opportunity to leverage our relationships with the agencies to inject capital back into the market. History shows that while we perform well during crises, we also excel as capital returns to the market, which takes time. Life insurance companies and banks need reassurance before fully re-engaging. We are confident that our business is well-positioned to benefit from these eventual market conditions.

Greg Florkowski, Executive Vice President and CFO

Okay. Thank you.

Kelsey Duffey, SVP of Investor Relations

Thank you Henry. We have no further questions at this time. So I will now turn the call back over to Willy for closing remarks.

Willy Walker, Chairman and CEO

Thank you everyone for joining us today. Thank you to the W&D team for a fantastic Q3. And as Greg and I both underscored while these are challenging times, we feel exceptionally well-positioned and we have a team that's engaged with our customers every single day and doing a fantastic job of providing capital and capital solutions to our clients. Thanks, everyone for joining us today. Thank you Ginna and Kelsey for all your work on this earnings call. Greg, well done and I hope everyone has a great day.