Walker & Dunlop, Inc. - Quarter Report: 2012 June (Form 10-Q)

Table of Contents

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

 

For the quarterly period ended June 30, 2012

 

OR

 

 

For the transition period from                   to                  

 

Commission File Number: 001-35000

 

Walker & Dunlop, Inc.

(Exact name of registrant as specified in its charter)

 

 

7501 Wisconsin Avenue, Suite 1200E

Bethesda, Maryland 20814

(301) 215-5500

(Address, including zip code, and telephone number, including

area code, of registrant’s principal executive offices)

 

Not Applicable

(Former name, former address, and former fiscal year if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

 

As of August 7, 2012 there were 22,847,041 total shares of common stock outstanding.

 

 

Table of Contents

 

Walker & Dunlop, Inc.
Form 10-Q
INDEX

 

						Page
PART I			FINANCIAL INFORMATION
Item 1.			Financial Statements			2
Item 2.			Management’s Discussion and Analysis of Financial Condition and Results of Operations			21
Item 3.			Quantitative and Qualitative Disclosures About Market Risk			33
Item 4.			Controls and Procedures			33
PART II			OTHER INFORMATION
Item 1.			Legal Proceedings			33
Item 1A.			Risk Factors			34
Item 2.			Unregistered Sales of Equity Securities and Use of Proceeds			37
Item 3.			Defaults Upon Senior Securities			37
Item 4.			Mine Safety Disclosures			37
Item 5.			Other Information			37
Item 6.			Exhibits			37
				Signature
				Exhibit Index
EX-4.3
EX-31.1
EX-31.2
EX-32
	EX- 101.1
	EX- 101.2
	EX- 101.3
	EX- 101.4
	EX- 101.5
	EX- 101.6

 

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PART I

 

FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Walker & Dunlop, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

June 30, 2012 and December 31, 2011

(In thousands, except share and per share data)

 

		June 30,			December 31,
		2012			2011
		(unaudited)
Assets
Cash and cash equivalents		$	46,153		$	53,817
Restricted cash		4,583			7,164
Pledged securities, at fair value		21,144			18,959
Loans held for sale, at fair value		399,230			268,167
Loans held for investment		16,392			—
Servicing fees and other receivables, net		17,540			18,501
Derivative assets		9,501			10,638
Mortgage servicing rights		149,533			137,079
Other assets		12,120			8,271
Total assets		$	676,196		$	522,596
Liabilities and Stockholders’ Equity
Liabilities
Accounts payable and other accrued expenses		$	66,942		$	76,163
Performance deposits from borrowers		7,552			10,425
Derivative liabilities		1,899			5,223
Guaranty obligation, net of accumulated amortization		10,746			9,921
Allowance for risk-sharing obligations		13,629			14,917
Warehouse notes payable		372,995			218,426
Notes payable		22,069			23,869
Total liabilities		$	495,832		$	358,944
Stockholders’ Equity
Stockholders’ equity:
Preferred shares, Authorized 50,000,000, none issued.		$	—		$	—
Common stock, $0.01 par value. Authorized 200,000,000; issued and outstanding 21,795,379 shares in 2012 and 21,748,598 shares in 2011.		218			217
Additional paid-in capital		82,770			81,190
Retained earnings		97,376			82,245
Total stockholders’ equity		$	180,364		$	163,652
Commitments and contingencies
Total liabilities and stockholders’ equity		$	676,196		$	522,596

 

See accompanying notes to condensed consolidated financial statements.

 

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Walker & Dunlop, Inc. and Subsidiaries

Condensed Consolidated Statements of Income

(In thousands, except share and per share data)

(Unaudited)

 

		For the three months ended June 30,						For the six months ended June 30,
		2012			2011			2012			2011
Revenues
Gains from mortgage banking activities		$	33,934		$	31,289		$	53,736		$	48,116
Servicing fees		9,827			8,047			19,206			15,760
Net warehouse interest income		1,074			1,059			2,011			1,776
Escrow earnings and other interest income		525			403			1,064			773
Other		1,360			1,608			5,105			4,978
Total revenues		$	46,720		$	42,406		$	81,122		$	71,403
Expenses
Personnel		$	17,363		$	12,863		$	29,004		$	22,070
Amortization and depreciation		6,743			5,084			14,002			9,991
Provision for risk-sharing obligations		750			1,764			1,974			2,510
Interest expense on corporate debt		163			214			331			466
Other operating expenses		6,592			4,263			11,208			7,283
Total expenses		$	31,611		$	24,188		$	56,519		$	42,320
Income from operations		$	15,109		$	18,218		$	24,603		$	29,083
Income tax expense		5,817			7,087			9,472			11,313
Net income		$	9,292		$	11,131		$	15,131		$	17,770
Basic earnings per share		$	0.43		$	0.51		$	0.70		$	0.82
Diluted earnings per share		$	0.42		$	0.51		$	0.69		$	0.82
Basic weighted average shares outstanding		21,779,379			21,629,463			21,764,976			21,606,233
Diluted weighted average shares outstanding		21,975,853			21,742,912			21,914,452			21,695,826

 

See accompanying notes to condensed consolidated financial statements.

 

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Walker & Dunlop, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

		Six Months Ended June 30,
		2012			2011
Cash flows from operating activities:
Net income		$	15,131		$	17,770
Adjustments to reconcile net income to net cash used in operating activities:
Gain attributable to fair value of future servicing rights, net of guaranty obligation		(26,365		)	(25,423		)
Gain on sale of MSR, less prepayment of MSR		(9		)	166
Provision for risk-sharing obligations		1,974			2,510
Amortization and depreciation		14,002			9,991
Originations of loans held for sale		(1,519,801		)	(1,319,853		)
Sales of loans to third parties		1,389,382			1,163,773
Stock compensation		1,709			1,043
Tax benefit from vesting of equity awards		5			—
Cash paid to settle risk-sharing obligations		(2,030		)	—
Amortization of leasehold inducement		(25		)	—
Cash allowance received from landlord		1,301			—
Changes in:
Restricted cash and pledged securities		396			(303		)
Servicing fees and other receivables		(357		)	(7,409		)
Derivative fair value adjustments		(1,543		)	(5,182		)
Other assets		(1,849		)	(652		)
Accounts payable and other accruals		(9,226		)	881
Performance deposits from borrowers		(2,873		)	4,628
Net cash used in operating activities		$	(140,178	)	$	(158,060	)
Cash flows from investing activities:
Capital expenditures		$	(3,760	)	$	(640	)
Net increase in loans held for investment		(16,367		)	—
Net cash used in investing activities		$	(20,127	)	$	(640	)
Cash flows from financing activities:
Borrowings from warehouse notes payable, net		$	154,569		$	163,548
Repayments of notes payable, net		(1,800		)	(1,952		)
Proceeds from issuance of common stock		1			2,053
Repurchase of common stock		(124		)	—
Tax benefit from vesting of equity awards		(5		)	—
Net cash provided by financing activities		$	152,641		$	163,649
Net (decrease) increase in cash and cash equivalents		$	(7,664	)	$	4,949
Cash and cash equivalents at beginning of period		53,817			33,285
Cash and cash equivalents at end of period		$	46,153		$	38,234
Supplemental Disclosure of Cash Flow Information:
Cash paid to third parties for interest		$	2,619		$	1,725
Cash paid for taxes		$	7,345		$	4,776

 

See accompanying notes to condensed consolidated financial statements.

 

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NOTE 1—ORGANIZATION AND BASIS OF PRESENTATION

 

These financial statements represent the condensed consolidated financial position and results of operations of Walker & Dunlop, Inc. and its subsidiaries. Unless the context otherwise requires, references to “we,” “us,” “our,” “Walker & Dunlop” and the “Company” mean the Walker & Dunlop consolidated companies. The statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. Because the accompanying condensed consolidated financial statements do not include all of the information and footnotes required by GAAP, they should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011. In the opinion of management, all adjustments (consisting only of normal recurring accruals except as otherwise noted herein) considered necessary for a fair presentation of the results for the Company in the interim periods presented have been included. Results of operations for the three and six months ended June 30, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012, or thereafter.

 

Walker & Dunlop is one of the leading commercial real estate finance companies in the United States, with a primary focus on multifamily lending. The Company originates, sells and services a range of multifamily and other commercial real estate financing products. The Company’s clients are owners and developers of commercial real estate across the country. The Company originates and sells loans pursuant to the programs of the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac,” and together with Fannie Mae, the government-sponsored enterprises, or the “GSEs”), the Government National Mortgage Association (“Ginnie Mae”) and the Federal Housing Administration, a division of the U.S. Department of Housing and Urban Development (together with Ginnie Mae, “HUD”), with which Walker & Dunlop has long-established relationships. The Company retains servicing rights and asset management responsibilities on nearly all loans that it sells to GSEs and HUD. Walker & Dunlop is approved as a Fannie Mae Delegated Underwriting and Servicing (“DUS”TM) lender nationally, a Freddie Mac Program Plus lender in seven states, the District of Columbia and the metropolitan New York area, a HUD Multifamily Accelerated Processing (“MAP”) lender nationally, and a Ginnie Mae issuer. The Company also originates and services loans for a number of life insurance companies and other institutional investors, in which cases it does not fund the loan but rather acts as a loan broker.

 

In July 2011, the Company launched its interim loan program offering floating-rate debt, for terms of up to two years, to experienced borrowers seeking to acquire or reposition multifamily properties that do not currently qualify for permanent financing. The Company closed its first loans under this program in 2012. The Company underwrites all loans originated through the program. During the time that they are outstanding, the Company assumes the full risk of loss on the loans.  In addition, the Company services and asset-manages loans originated through the program, with the ultimate goal of providing permanent financing on the properties. These loans are classified as held for investment on the Company’s balance sheet during such time that they are outstanding.

 

W&D Balanced Real Estate Fund I GP, LLC, a wholly owned subsidiary, has a general partnership interest in a partnership that invests in commercial real estate. The Company can be removed as general partner at the sole discretion of one of the limited partners. Walker & Dunlop Real Estate Opportunity Fund I Manager, LLC, a wholly owned subsidiary, is the managing member of a limited liability company that invests in commercial real estate. The Company can be removed as the managing member at the sole discretion of one of the members. In their respective capacities as general partner and managing member, the wholly owned subsidiaries of the Company earn fees pursuant to corporate services agreements under which they provide consulting and overhead services to the partnership and limited liability company.

 

NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Principles of Consolidation—The condensed consolidated financial statements include the accounts of the Company as defined in Note 1. All material intercompany transactions have been eliminated. The Company has evaluated all subsequent events.

 

Use of Estimates—The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, including guaranty obligations, capitalized mortgage servicing rights, derivative instruments and hedging relationships, and the disclosure of contingent assets and liabilities. Actual results may vary from these estimates.

 

Comprehensive Income—For the three and six months ended June 30, 2012 and 2011, comprehensive income equaled net income; therefore, a separate statement of comprehensive income is not included in the accompanying condensed consolidated financial statements.

 

Concentrations of Credit Risk—Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of cash and cash equivalents, loans held for sale and derivative financial instruments.

 

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The Company places the cash and temporary investments with high-credit-quality financial institutions and believes no significant credit risk exists. The counterparties to the loans held for sale and funding commitments are owners of residential multifamily properties located throughout the United States. Mortgage loans are generally transferred or sold within 60 days from the date that a mortgage loan is funded.

 

There is no material counterparty risk with respect to the Company’s funding commitments in that each potential borrower must make a non-refundable good faith deposit when the funding commitment is executed. The counterparty to the forward sale is generally an investment bank. There is a risk that the purchase price agreed to by the investor will be reduced in the event of a late delivery. The risk for non-delivery of a loan primarily results from the risk that a borrower does not close on the funding commitment in a timely manner, which generally is a risk mitigated by the non-refundable good faith deposit.

 

Loans Held for Sale—Loans held for sale represent originated loans that are generally transferred or sold within 60 days from the date that a mortgage loan is funded. The Company initially measures all originated loans at fair value. Subsequent to initial measurement, the Company measures all mortgage loans at fair value, unless the Company documents at the time the loan is originated that it will measure the specific loan at the lower of cost or fair market value for the life of the loan. Electing to use fair value allows a better offset of the change in fair value of the loan and the change in fair value of the derivative instruments used as economic hedges. During the period prior to its sale, interest income on a loan held for sale is calculated in accordance with the terms of the individual loan. There were no loans held for sale that were valued at the lower of cost or market or on a non-accrual status at June 30, 2012 and December 31, 2011.

 

Gains from Mortgage Banking Activities— Mortgage banking activity income is recognized when the Company records a derivative asset upon the commitment to originate a loan with a borrower and sell the loan to an investor. This commitment asset is recognized at fair value, which reflects the fair value of the contractual loan origination related fees and sale premiums, net of co-broker fees, and the estimated fair value of the expected net future cash flows associated with the servicing of the loan net of the estimated net future cash flows associated with any risk-sharing obligations. Loans originated in a brokerage capacity tend to have lower origination fees because they often require less time to execute, there is more competition for brokerage assignments and because the borrower will also have to pay an origination fee to the ultimate institutional lender. Also included in gains from mortgage banking activities are changes to the fair value of loan commitments, forward sale commitments, and loans held for sale that occur during their respective holding periods. Upon sale of the loans, no gains or losses are recognized as such loans are recorded at fair value during their holding periods. Mortgage servicing rights and guaranty obligations are recognized as assets or liabilities, respectively, upon the sale of the loans.

 

The co-broker fees for the three and six months ended June 30, 2012 were $4.7 million and $8.2 million; and were $8.5 million and $13.8 million for the three and six months ended June 30, 2011, respectively.

 

Transfer of financial assets is reported as a sale when (a) the transferor surrenders control over those assets and (b) consideration other than beneficial interests in the transferred assets is received in exchange. The transferor is considered to have surrendered control over transferred assets if, and only if, certain conditions are met. The Company has determined that all loans sold have met these specific conditions and accounts for all transfers of mortgage loans and mortgage participations as completed sales.

 

When a mortgage loan is sold, the Company retains the right to service the loan and initially recognizes the mortgage servicing right (“MSR”) at fair value. Subsequent to the initial measurement date, mortgage servicing assets are amortized using the effective interest method.

 

Guaranty obligation and allowance for risk-sharing obligations—When a loan is sold under the Fannie Mae DUS program, the Company undertakes an obligation to partially guarantee the performance of the loan. At inception, a liability for the fair value of the obligation undertaken in issuing the guaranty is recognized. The fair value includes the Company’s obligation to stand ready to perform over the term of the guaranty (the non-contingent guaranty), and the Company’s obligation to make future payments should those triggering events or conditions occur (contingent guaranty).

 

Historically, the contingent guaranty recognized at inception has been de minimis. In determining the fair value of the guaranty obligation, we consider the risk profile of the collateral, historical loss experience, and various market indicators. Generally, the estimated fair value of the guaranty obligation is based on the present value of the future cash flows expected to be paid under the guaranty over the estimated life of the loan (historically three to five basis points per year) discounted using a 12-15 percent discount rate. The discount rate and estimated life used are consistent with those used for the calculation of the MSR for each loan.

 

Subsequent to the initial measurement date, the liability is amortized over the life of the guaranty period using the straight-line method. We evaluate the allowance for risk-sharing obligations by monitoring the performance of each loan for events or conditions which may signal a potential default. In instances where payment under the guaranty on a specific loan is determined to be probable and estimable, we record an additional liability for the estimated allowance for risk-sharing through a charge to the provision for risk-

 

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sharing obligations, along with a write-off of the associated loan-specific MSR (Note 5).

 

Loans Held for Investment—Loans held for investment are interim loans originated by the Company for properties that currently do not qualify for permanent GSE or HUD financing. These loans have a maximum term of two years. The loans are carried at their unpaid principal balances adjusted for net unamortized loan fees and costs, and net of any allowance for loan losses. Interest income is accrued based on the actual coupon rate and is recognized as revenue when earned and deemed collectible.

 

The Company uses the interest method to determine an effective yield to amortize the loan fees and costs on real estate loans held for investment. The Company uses the initial coupon interest rate of the loans (without regard to future changes in the underlying indices) and anticipated principal payments, if any, to determine periodic amortization.

 

The Company will reclassify loans held-for-investment as loans held-for-sale if it determines that the loans will be sold or transferred to third parties.

 

Share-Based Payment—The Company recognizes compensation costs for all share-based payment awards made to employees and directors, including restricted stock, employee stock options and other forms of equity compensation based on the grant date fair value.

 

Under the Walker & Dunlop, Inc. 2010 Equity Incentive Plan, the Company has granted restricted stock, unrestricted stock and stock option awards. Restricted stock awards have been granted without cost to the Company’s officers, employees and non-employee directors, for which the fair value of the award was calculated as the difference between the market value of the Company’s common stock on the date of grant and the purchase price to be paid by the grantee. The Company’s stock option and restricted stock awards for its officers and employees vest, predicated on continued employment, over periods of two to three years. Restricted stock awards for non-employee directors fully vest after one year.

 

Stock option awards have been granted to officers and certain other employees, with an exercise price equal to the closing price of the Company’s common stock on the date of the grant, and were granted for a ten-year term, vesting ratably over three years dependent solely on continued employment. To estimate the grant-date fair value of stock options, the Company uses the Black-Scholes pricing model. The Black-Scholes model estimates the per share fair value of an option on its date of grant based on the following inputs: the option’s exercise price, the price of the underlying stock on the date of the grant, the expected option term, the estimated dividend yield, a “risk-free” interest rate and the expected volatility. For the “risk-free” rate, the Company uses a U.S. Treasury strip due in a number of years equal to the option’s expected term. To determine the expected volatility, the Company has calculated the volatility of the common stock price of a group of peer companies, as the Company has insufficient historical data for its common stock at this time to develop an expectation of volatility over the expected term of the options granted solely based on the historical volatility of its own common stock.

 

Compensation expense is adjusted for estimated forfeitures and is recognized on a straight-line basis, for the entire award, over the requisite service period of the award. Forfeiture assumptions are evaluated on a quarterly basis and updated as necessary. Compensation is recognized within the income statement as “Personnel” expense, the same expense line as the cash compensation paid to the respective employees.

 

Income Taxes—The Company files income tax returns in the applicable U.S. federal, state and local jurisdictions and generally is subject to examination by the respective jurisdictions for three years from the filing of a tax return. The Company accounts for income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities from a change in tax rates is recognized in earnings in the period when the new rate is enacted.

 

Deferred tax assets are recognized only to the extent that it is more likely than not that they will be realizable based on consideration of available evidence, including future reversals of existing taxable temporary differences, projected future taxable income and tax planning strategies. Net deferred tax liabilities are included in “Accounts payable and other accrued expenses” in the accompanying condensed consolidated balance sheets.

 

We had no accruals for tax uncertainties as of June 30, 2012 or December 31, 2011.

 

Net Warehouse Interest Income—The Company presents warehouse interest income net of warehouse interest expense. Warehouse interest income is the interest earned from loans that are held for sale. Substantially all loans that are held for sale are financed with matched borrowings under our warehouse facilities incurred to fund a specific loan held for sale. Warehouse interest expense is incurred on borrowings used to fund loans solely while they are held for sale. Warehouse interest income and expense are earned or incurred after a loan is closed and before a loan is sold. Included in net warehouse interest income for the three and six

 

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months ended June 30, 2012 and 2011 are the following components (in thousands):

 

		For the three months ended June 30,						For the six months ended June 30,
		2012			2011			2012			2011
Warehouse interest income		$	2,978		$	2,380		$	5,553		$	4,101
Warehouse interest expense		1,904			1,321			3,542			2,325
Net warehouse interest income		$	1,074		$	1,059		$	2,011		$	1,776

 

Recently Issued Accounting Pronouncements—In May 2011, the FASB issued ASU No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. ASU No. 2011-04 was issued to achieve common fair value measurement and disclosure requirements between U.S. GAAP and International Financial Reporting Standards. ASU No. 2011-04 amends current fair value measurement and disclosure guidance to include increased transparency around valuation inputs and investment categorization. The adoption of ASU No. 2011-04 expanded our disclosures regarding fair value measurements but did not have a material impact on our financial statement disclosures.

 

In June 2011, the FASB issued ASU No. 2011-05, Presentation of Comprehensive Income. ASU No. 2011-05 allows an entity to have the option to present the components of net income and comprehensive income in either one or two consecutive financial statements. ASU No. 2011-05 eliminates the current option to report other comprehensive income and its components in the statement of changes in equity. While the new guidance changes the presentation of comprehensive income, there are no changes to the components that are recognized in net income or other comprehensive income under current accounting guidance. The adoption of ASU No. 2011-05 did not have a material impact on our financial statements.

 

NOTE 3—ACQUISITION OF CWCAPITAL LLC

 

On June 7, 2012, the Company and its indirect wholly owned subsidiary, Walker & Dunlop, LLC (the “Purchaser”), entered into an agreement to acquire CWCapital LLC (“CWCapital”), a direct wholly owned subsidiary of CW Financial Services LLC (“CW Financial”), pursuant to a purchase agreement of the same date, by and among the Company, the Purchaser, CW Financial and CWCapital (the “Purchase Agreement”).

 

On the terms and subject to the conditions of the Purchase Agreement, the Purchaser will acquire all of CW Financial’s interests in CWCapital for approximately $220 million, net of certain expenses and adjustments (the “Acquisition”).  Of the $220 million, $80 million will be paid in cash from the Purchaser, through a combination of existing capital and financing anticipated to be obtained.  The remaining $140 million will be paid through the issuance of shares of the Company’s common stock (the “Stock Consideration”).  Upon the closing of the Acquisition, it is anticipated that the Stock Consideration will total, and CW Financial will thereby own, approximately 11.6 million shares of the Company’s common stock, or approximately 34 percent of the Company on a fully diluted basis, subject to the adjustments described in the next sentence.  Pursuant to the Purchase Agreement, the number of shares constituting the Stock Consideration is fixed at such 11.6 million shares (and the common stock price at $12.02) within a “collar” of a 30 percent upward or downward fluctuation in the volume weighted average price of the common stock within the 20 consecutive trading days immediately preceding the third trading day prior to the closing date, outside of which “collar” the number of shares constituting the Stock Consideration would be variable based on the price of the common stock.  In accordance with the terms of the Purchase Agreement, CW Financial may not transfer the Stock Consideration for a period of 180 days after the closing of the Acquisition.

 

Pursuant to the rules of the New York Stock Exchange (which require the Company to obtain stockholder approval prior to issuing common stock, if the issuance would constitute more than 20 percent of the total number of shares of common stock outstanding before the issuance), the issuance of the Stock Consideration is subject to approval by the vote of a majority of the shares of the Company’s common stock entitled to vote at a meeting held for that purpose.  As the Company previously reported, the date of the special stockholder meeting for approving of the Company’s issuance of the Stock Consideration is August 30, 2012.  The completion of the Acquisition is subject to various other conditions, including obtaining certain regulatory approvals and the approval of certain governmental authorities.  Subject to the satisfaction or waiver of the closing conditions of the Purchase Agreement, the Company expects the Acquisition to close by the end of the third quarter of 2012.

 

NOTE 4—GAINS FROM MORTGAGE BANKING ACTIVITIES

 

The gains from mortgage banking activities consist of the following activity for the three and six months ended June 30, 2012 and 2011 (in thousands):

 

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		For the three months ended June 30,						For the six months ended June 30,
		2012			2011			2012			2011
Contractual loan origination related fees, net		$	17,092		$	15,335		$	27,371		$	22,693
Fair value of expected future cash flows from servicing recognized at commitment		18,083			16,495			28,167			26,550
Fair value of expected guaranty obligation		(1,241		)	(541		)	(1,802		)	(1,127		)
Total gains from mortgage banking activities		$	33,934		$	31,289		$	53,736		$	48,116

 

NOTE 5—MORTGAGE SERVICING RIGHTS

 

Mortgage servicing rights (MSR) represent the fair value of the servicing rights retained by the Company for mortgage loans originated and sold. The capitalized amount is equal to the estimated fair value of the future expected net cash flows associated with the servicing rights. The following describes the key assumptions used in calculating each loan’s MSR:

 

Discount rate—Depending upon loan type, the discount rate used is management’s best estimate of market discount rates. The rates used for loans originated were 10% to 15% for each of the three month periods presented.

 

Estimated Life—The estimated life of the MSRs approximates the stated maturity date of the underlying loan and may be reduced by 6 to 12 months based upon the expiration of various types of prepayment penalty and/or lockout provisions prior to that stated maturity date.

 

Servicing Cost—The estimated future cost to service the loan for the estimated life of the MSR is subtracted from the estimated future cash flows.

 

The fair value of the MSRs was $176.2 million and $158.5 million at June 30, 2012 and December 31, 2011, respectively. The Company uses a discounted static cash flow valuation approach and the key economic assumption is the discount rate. For example see the following sensitivities:

 

The impact of a 100 basis point increase in the discount rate at June 30, 2012, is a decrease in the fair value of $5.3 million.

 

The impact of a 200 basis point increase in the discount rate at June 30, 2012, is a decrease in the fair value of $10.2 million.

 

Activity related to capitalized MSRs for the three and six months ended June 30, 2012 and 2011 was as follows (in thousands):

 

		For the three months ended June 30,						For the six months ended June 30,
		2012			2011			2012			2011
Beginning balance		$	142,621		$	112,829		$	137,079		$	106,189
Additions, following the sale of loan		13,837			11,237			26,864			23,132
Amortization		(6,701		)	(5,200		)	(13,051		)	(10,169		)
Pre-payments and write-offs		(224		)	(269		)	(1,359		)	(555		)
Ending balance		$	149,533		$	118,597		$	149,533		$	118,597

 

The MSRs are being amortized in proportion to, and over the period, that net servicing income is expected to be received using the effective interest method. The Company reported write downs of MSRs related to loans that were repaid prior to the expected maturity or the servicing rights being sold. These write-offs are included with the amortization and depreciation expense in the accompanying condensed consolidated statements of income.

 

Management reviews the capitalized MSRs for impairment quarterly. MSRs are measured for impairment on an asset-by-asset basis, considering factors such as debt service coverage ratio, property location, loan-to-value ratio and property type. In addition, at each reporting period, we compare the aggregate carrying value of the MSR portfolio to the aggregate estimated fair value of the

 

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portfolio. No impairments other than write-offs discussed above have been recognized for the periods presented.

 

NOTE 6—GUARANTY OBLIGATION AND ALLOWANCE FOR RISK-SHARING OBLIGATIONS

 

When a loan is sold under the Fannie Mae DUS program, the Company typically agrees to guarantee a portion of the ultimate loss incurred on the loan should the borrower fail to perform. The compensation for this risk is a component of the servicing fee on the loan. No guaranty is provided for loans sold under the Freddie Mac or HUD loan programs.

 

A summary of our guaranty obligation for the three and six months ended June 30, 2012 and 2011 is as follows (in thousands):

 

		For the three months ended June 30,						For the six months ended June 30,
		2012			2011			2012			2011
Beginning balance		$	10,447		$	9,136		$	9,921		$	8,928
Guaranty obligation recognized, following the sale of loan		785			690			1,787			1,279
Amortization of guaranty obligation		(486		)	(428		)	(962		)	(809		)
Ending Balance		$	10,746		$	9,398		$	10,746		$	9,398

 

We evaluate the allowance for risk-sharing obligations by monitoring the performance of each loan for triggering events or conditions that may signal a potential default. In situations where payment under the guaranty is probable and estimable on a specific loan, we record an additional liability for the estimated allowance for risk-sharing through a charge to the provision for risk-sharing obligations in the income statement, along with a write-off of the loan-specific MSR. The amount of the provision reflects our assessment of the likelihood of payment by the borrower, the estimated disposition value of the underlying collateral and the level of risk-sharing. Historically, the loss recognition occurs at or before the loan becoming 60 days delinquent. A summary of our allowance for risk-sharing for the three and six months ended June 30, 2012 and 2011 is as follows (in thousands):

 

		For the three months ended June 30,						For the six months ended June 30,
		2012			2011			2012			2011
Beginning balance		$	14,522		$	11,619		$	14,917		$	10,873
Provision for risk sharing obligations		750			1,764			1,974			2,510
Write-offs		(1,643		)	—			(3,262		)	—
Ending Balance		$	13,629		$	13,383		$	13,629		$	13,383

 

As of June 30, 2012, the maximum quantifiable contingent liability associated with the Company’s guarantees under the Fannie Mae DUS agreement was $1.9 billion. The maximum quantifiable contingent liability is not representative of the actual loss we would incur. We would be liable for this amount only if all of the loans we service for Fannie Mae, for which we retain some risk of loss, were to default and all of the collateral underlying these loans was determined to be without value at the time of settlement.

 

NOTE 7—SERVICING

 

The total amount of loans the Company was servicing for various institutional investors was $17.6 billion as of June 30, 2012.

 

NOTE 8—NOTES PAYABLE

 

Warehouse notes payable—To provide financing to borrowers under GSE and HUD programs, and to assist in funding loans held for investment, the Company has arranged for committed warehouse lines of credit in the amount of $535 million with certain national banks and a $250 million uncommitted facility with Fannie Mae. In support of each of these credit facilities, the Company has pledged substantially all of its loans held for sale and all of its loans held for investment under the Company’s approved programs.  At June 30, 2012, borrowings aggregated $373.0 million under the warehouse facilities. The borrowing rates under these warehouse facilities continue to be computed based on the average 30-day LIBOR plus 1.15% to 2.50%.

 

For the three months ended June 30, 2012 and 2011, the Company incurred interest expense on its warehouse facilities of $1.9 million and $1.3 million; and for the six months ended June 30, 2012 and 2011, the Company incurred interest expense on its warehouse facilities of $3.5 million and $2.3 million, respectively. Included in interest expense were loan fees of $0.4 million and $0.3 million for the three months ended June 30, 2012 and 2011; and fees of $0.7 million and $0.5 million for the six months ended June 30, 2012 and 2011, respectively. The notes payable are subject to various financial covenants and the Company was in compliance with all such covenants at June 30, 2012.

 

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On March 8, 2012, the Company amended its $150 million committed warehouse agreement that was scheduled to mature on June 29, 2012. The amendment extended the maturity date to February 28, 2013, increased the credit limit from $150 million to $350 million, and reduced the rate for borrowing from the average 30-day LIBOR plus 200 basis points to the average 30-day LIBOR plus 185 basis points.

 

The Company had an unlimited master purchase and sale agreement which expired on March 16, 2012. In anticipation of the expiration of the master purchase and sale agreement, the Company amended one of its committed warehouse lines as described above, and on March 16, 2012, the Company allowed the master purchase and sale agreement to expire.

 

NOTE 9—FAIR VALUE MEASUREMENTS

 

The Company uses valuation techniques that are consistent with the market approach, the income approach and/or the cost approach to measure assets and liabilities that are measured at fair value. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, accounting standards establish a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

 

·                  Level 1—Financial assets and liabilities whose values are based on unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access.

 

·                  Level 2—Financial assets and liabilities whose values are based on inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.

 

·                  Level 3—Financial assets and liabilities whose values are based on inputs that are both unobservable and significant to the overall valuation.

 

The Company’s MSRs are measured at fair value on a nonrecurring basis. That is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). The Company’s MSRs do not trade in an active, open market with readily observable prices. While sales of MSRs do occur, precise terms and conditions vary with each transaction and are not readily available. Accordingly, the estimated fair value of MSRs was developed using discounted cash flow models that calculate the present value of estimated future net servicing income. The model considers contractually specified servicing fees, prepayment assumptions, delinquency rates, late charges, other ancillary revenue, costs to service and other economic factors. The Company reassesses and periodically adjusts the underlying inputs and assumptions used in the model to reflect observable market conditions and assumptions that a market participant would consider in valuing an MSR asset. MSRs are carried at the lower of amortized cost or estimated fair value.

 

A description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. These valuation methodologies were applied to all of the Company’s assets and liabilities carried at fair value:

 

·                  Derivative Instruments—The derivative positions consist of interest rate lock commitments and forward sale agreements. These instruments are valued using a discounted cash flow model developed based on changes in the U.S. Treasury rate and other observable market data. The value was determined after considering the potential impact of collateralization, adjusted to reflect nonperformance risk of both the counterparty and the Company and are classified within Level 3 of the valuation hierarchy.

 

·                  Loans held for sale—The loans held for sale are reported at fair value. The Company determines the fair value of the loans held for sale using discounted cash flow models that incorporate quoted observable prices from market participants. Therefore, the Company classifies these loans held for sale as Level 2.

 

·                  Pledged Securities—The pledged securities are valued using quoted market prices from recent trades. Therefore, the Company classifies pledged securities as Level 1.

 

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The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of June 30, 2012, and December 31, 2011, segregated by the level of the valuation inputs within the fair value hierarchy used to measure fair value (in thousands):

 

		Quoted Prices in			Significant			Significant
		Active Markets			Other			Other
		For Identical			Observable			Unobservable
		Assets			Inputs			Inputs			Balance as of
		(Level 1)			(Level 2)			(Level 3)			Period End
June 30, 2012
Assets
Loans held for sale		$	—		$	399,230		$	—		$	399,230
Pledged securities		21,144			—			—			21,144
Derivative assets		—			—			9,501			9,501
Total		$	21,144		$	399,230		$	9,501		$	429,875
Liabilities
Derivative liabilities		$	—		$	—		$	1,899		$	1,899
Total		$	—		$	—		$	1,899		$	1,899
December 31, 2011
Assets
Loans held for sale		$	—		$	268,167		$	—		$	268,167
Pledged securities		18,959			—			—			18,959
Derivative assets		—			—			10,638			10,638
Total		$	18,959		$	268,167		$	10,638		$	297,764
Liabilities
Derivative liabilities		$	—		$	—		$	5,223		$	5,223
Total		$	—		$	—		$	5,223		$	5,223

 

There were no transfers into or out of assets that are considered Level 1 or Level 2 fair value measurements.

 

Derivative instruments (Level 3) are outstanding for short periods of time (generally less than 60 days) and are not outstanding for more than one period. A roll forward of derivative instruments which require valuations based upon significant unobservable inputs, is presented below for the six months ended June 30, 2012 and 2011 (in thousands):

 

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		Fair Value Measurements
		Using Significant
		Unobservable Inputs:
		Derivative Instruments
		June 30, 2012
Derivative assets and liabilities, net
Beginning balance, December 31, 2011		$	5,415
Transfers in (out) of Level 3		—
Purchases		—
Sales		—
Issuances		—
Settlements		(51,549		)
Realized gains (losses) recorded in earnings		46,134
Unrealized gains (losses) recorded in earnings		7,602
Ending balance, June 30, 2012		$	7,602

 

		Derivative Instruments
		June 30, 2011
Derivative assets and liabilities, net
Beginning balance, December 31, 2010		$	4,900
Transfers in (out) of Level 3		—
Purchases		—
Sales		—
Issuances		—
Settlements		(43,324		)
Realized gains (losses) recorded in earnings		38,424
Unrealized gains (losses) recorded in earnings		9,692
Ending balance, June 30, 2011		$	9,692

 

The following table presents information about significant unobservable inputs used in the measurement of the fair value of Company’s Level 3 assets and liabilities:

 

		Quantitative Information about Level 3 Measurements
		Fair Value			Valuation Technique		Unobservable Input (1)		Input Value (1)
Derivative assets		$	9,501		Discounted cash flow		Counterparty credit risk		—
Derivative liabilities		1,899			Discounted cash flow		Counterparty credit risk		—

 

(1)         Significant increases (decreases) in this input may lead to significantly lower (higher) fair value measurements.

 

The carrying amounts and the fair values of the Company’s financial instruments as of June 30, 2012, and December 31, 2011, are presented below (in thousands):

 

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		June 30, 2012
		Carrying			Fair
		Amount			Value
Financial Assets:
Cash and cash equivalents		$	46,153		$	46,153
Restricted cash		4,583			4,583
Pledged securities		21,144			21,144
Loans held for sale		399,230			399,230
Loans held for investment		16,392			16,500
Derivative assets		9,501			9,501
Total		$	497,003		$	497,111
Financial Liabilities:
Derivative liabilities		$	1,899		$	1,899
Warehouse notes payable		372,995			372,995
Notes payable		22,069			22,069
Total		$	396,963		$	396,963

 

		December 31, 2011
		Carrying			Fair
		Amount			Value
Financial Assets:
Cash and cash equivalents		$	53,817		$	53,817
Restricted cash		7,164			7,164
Pledged securities		18,959			18,959
Loans held for sale		268,167			268,167
Derivative assets		10,638			10,638
Total		$	358,745		$	358,745
Financial Liabilities:
Derivative liabilities		$	5,223		$	5,223
Warehouse notes payable		218,426			218,426
Notes payable		23,869			23,869
Total		$	247,518		$	247,518

 

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

 

Cash and Cash Equivalents and Restricted Cash—The carrying amounts, at face value or cost plus accrued interest, approximate fair value because of the short maturity of these instruments.

 

Pledged Securities—Consist of highly liquid investments in commercial paper of AAA rated entities and investments in money market accounts invested in government securities. Investments typically have maturities of 90 days or less, and are valued using quoted market prices from recent trades.

 

Loans Held For Sale—Consist of originated loans that are generally transferred or sold within 60 days from the date that a mortgage loan is funded, and are valued using discounted cash flow models that incorporate observable prices from market participants.

 

Loans Held For Investment—Consist of originated interim loans which the Company expects to hold for investment for periods of up to two years, and are valued using discounted cash flow models that incorporate observable prices from market participants.

 

Derivative Instruments—Consist of interest rate lock commitments and forward sale agreements. These instruments are valued using discounted cash flow models developed based on changes in the U.S. Treasury rate and other observable market data. The value is determined after considering the potential impact of collateralization, adjusted to reflect nonperformance risk of both the counterparty and the Company.

 

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Warehouse Notes Payable—Consist of borrowings outstanding under warehouse line agreements. The borrowing rates on the warehouse lines are based upon average 30-day LIBOR plus a margin. The carrying amounts approximate fair value because of the short maturity of these instruments.

 

Notes Payable—Consist of borrowings outstanding under term note agreements. The borrowing rates on the notes payable are based upon average 30-day LIBOR plus a margin. We estimate the fair value by discounting the future cash flows of each instrument at market rates.

 

Fair Value of Derivative Instruments and Loans Held for Sale—In the normal course of business, the Company enters into contractual commitments to originate (purchase) and sell multifamily mortgage loans at fixed prices with fixed expiration dates. The commitments become effective when the borrowers “lock-in” a specified interest rate within time frames established by the Company. All mortgagors are evaluated for creditworthiness prior to the extension of the commitment. Market risk arises if interest rates move adversely between the time of the “lock-in” of rates by the borrower and the sale date of the loan to an investor.

 

To mitigate the effect of the interest rate risk inherent in providing rate lock commitments to borrowers, the Company’s policy is to enter into a sale commitment with the investor simultaneously with the rate lock commitment with the borrower. The sale contract with the investor locks in an interest rate and price for the sale of the loan. The terms of the contract with the investor and the rate lock with the borrower are matched in substantially all respects, with the objective of eliminating interest rate risk to the extent practical. Sale commitments with the investors have an expiration date that is longer than our related commitments to the borrower to allow, among other things, for the closing of the loan and processing of paperwork to deliver the loan into the sale commitment.

 

Both the rate lock commitments to borrowers and the forward sale contracts to buyers are undesignated derivatives and, accordingly, are marked to fair value through other income and expenses. The fair value of the Company’s rate lock commitments to borrowers and loans held for sale and the related input levels includes, as applicable:

 

·                  the assumed gain/loss of the expected resultant loan sale to the buyer;

·                  the expected net future cash flows associated with servicing the loan (Level 2);

·                  the effects of interest rate movements between the date of the rate lock and the balance sheet date (Level 2); and

·                  the nonperformance risk of both the counterparty and the Company (Level 3).

 

The fair value of the Company’s forward sales contracts to investors considers effects of interest rate movements between the trade date and the balance sheet date (Level 2). The market price changes are multiplied by the notional amount of the forward sales contracts to measure the fair value.

 

The assumed gain/loss considers the amount that the Company has discounted the price to the borrower from par for competitive reasons, if at all, and the expected net cash flows from servicing to be received upon securitization of the loan. The fair value of the expected net future cash flows associated with servicing the loan is calculated pursuant to the valuation techniques described previously for mortgage servicing rights.

 

To calculate the effects of interest rate movements, the Company uses applicable published U.S. Treasury prices, and multiplies the price movement between the rate lock date and the balance sheet date by the notional loan commitment amount.

 

The fair value of the Company’s forward sales contracts to investors considers the market price movement of the same type of security between the trade date and the balance sheet date (Level 2). The market price changes are multiplied by the notional amount of the forward sales contracts to measure the fair value.

 

The fair value of the Company’s interest rate lock commitments and forward sales contracts is adjusted to reflect the risk that the agreement will not be fulfilled. The Company’s exposure to nonperformance in rate lock and forward sale contracts is represented by the contractual amount of those instruments. Given the credit quality of our counterparties, the short duration of interest rate lock commitments and forward sale contracts, and the Company’s historical experience with the agreements, the risk of nonperformance by the Company’s counterparties is not significant.

 

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		Fair Value Adjustment Components												Balance Sheet Location
																				Fair Value
		Notional or			Assumed			Interest Rate			Total			Derivative			Derivative			Adjustment
		Principal			Gain (Loss)			Movement			Fair Value			Contract			Contract			To Loans
(in thousands)		Amount			on Sale			Effect			Adjustment			Assets			Liabilities			Held for Sale
June 30, 2012
Rate lock commitments		$	212,076		$	8,418		$	(418	)	$	8,000		$	8,000		$	—		$	—
Forward sale contracts		598,843			—			(398		)	(398		)	1,501			(1,899		)	—
Loans held for sale		386,767			11,647			816			12,463			—			—			12,463
Total					$	20,065		$	—		$	20,065		$	9,501		$	(1,899	)	$	12,463
December 31, 2011
Rate lock commitments		$	226,455		$	7,781		$	2,785		$	10,566		$	10,566		$	—		$	—
Forward sale contracts		482,751			—			(5,151		)	(5,151		)	72			(5,223		)
Loans held for sale		256,296			9,505			2,366			11,871			—			—			11,871
Total					$	17,286		$	—		$	17,286		$	10,638		$	(5,223	)	$	11,871

 

NOTE 10—LITIGATION, COMMITMENTS AND CONTINGENCIES

 

Fannie Mae DUS Related Commitments—Commitments for the origination and subsequent sale and delivery of loans to Fannie Mae represent those mortgage loan transactions where the borrower has locked an interest rate and scheduled closing and the Company has entered into a mandatory delivery commitment to sell the loan to Fannie Mae. As discussed in Note 9, the Company accounts for these commitments as derivatives recorded at fair value.

 

The Company is generally required to share the risk of any losses associated with loans sold under the Fannie Mae DUS program (the DUS risk-sharing obligations). The Company is required to secure this obligation by assigning restricted cash balances and securities to Fannie Mae. The reserve for loans may be posted over the first 48 months. As of June 30, 2012, the Company had pledged cash and securities in excess of these requirements. In 2010, Fannie Mae increased its collateral requirements for Tier II loans by approximately 25 basis points effective April 1, 2011. In January 2012, Fannie Mae notified its Multifamily DUS lenders that collateral requirements on Fannie Mae Tier II, III and IV loans will remain unchanged for 2012. However, collateral requirements for existing and new Fannie Mae Tier I loans will increase from 50 basis points to 90 basis points and that Level 2 and Level 3 loss sharing requirements will increase. We currently have an insignificant number of loans in our portfolio which will be affected by the announced collateral changes and do not expect it will have a material impact on our future operations; however, future changes to collateral requirements may adversely impact us. Based on our aggregate Fannie Mae portfolio as of June 30, 2012, the total incremental collateral required for all existing loans over the life of the portfolio, in accordance with Fannie Mae requirements, is expected to be approximately $17.8 million. Under the provisions of the DUS agreement, the Company must also maintain a certain level of liquid assets referred to as the operational and unrestricted portions of the required reserves each year. These requirements were satisfied by the Company as of June 30, 2012 and June 30, 2011.

 

For most loans we service under the Fannie Mae DUS program, we are currently required to advance 100% of the principal and interest due to noteholders up to 5% of the unpaid principal balance if the borrower is delinquent in making loan payments. Under the HUD program, we are required to advance 100% of the principal and interest payments due to noteholders if the borrower is delinquent in making loan payments. Advances are included in loan origination related fees and other receivables to the extent such amounts are recoverable.

 

Fannie Mae has established benchmark standards for capital adequacy, and reserves the right to terminate the Company’s servicing authority for all or some of the portfolio, if at any time it determines that the Company’s financial condition is not adequate to support its obligation under the DUS agreement. The Company is required to maintain acceptable net worth as defined in the agreement, and the Company satisfied the requirements as of June 30, 2012. The net worth requirement is derived primarily from unpaid balances on Fannie Mae loans and the level of risk-sharing. At June 30, 2012, the net worth requirement was $52.4 million and the Company’s net worth was $203.6 million, as defined. As of June 30, 2012, we were required to maintain at least $9.6 million of liquid assets to meet our operational liquidity requirements, as defined in the agreements, for Fannie Mae, Freddie Mac, HUD and Ginnie Mae. As of June 30, 2012, we had operational liquidity of $45.6 million.

 

Litigation—Capital Funding litigation— On February 17, 2010, Capital Funding Group, Inc. (“Capital Funding”) filed a lawsuit in the state Circuit Court of Montgomery County, Maryland against Walker & Dunlop, LLC, our wholly owned subsidiary, for alleged breach of contract, unjust enrichment and unfair competition arising out of an alleged agreement that Capital Funding had with

 

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