Walker & Dunlop, Inc. (WD) Earnings Call Transcript & Summary

My friend Dr. Mohamed El-Erian joined me today. Mohamed came to Sun Valley for the Walker & Dunlop Summer Conference last summer, and we published out on the Walker Webcast that face-to-face interview, we did. And here we are six months later. A lot in our worlds has changed, and I am honored to have Dr. El-Erian back on the Walker Webcast. Mohamed, let me do a quick bio, not that it's needed for you but just quick to remind some people of the perspective that you bring to my questions today and then we'll dive into the conversation. Dr. Mohamed El-Erian is the President of Queens' College at Cambridge University. He serves as Chief Economic Adviser at Allianz, the corporate parent of PIMCO, where he was Chief Executive and Co-Chief Investment Officer between 2007 and 2014. He is Chair of Gramercy Fund Management. He is a columnist for Bloomberg Opinion and a contributing editor at The Financial Times. He's a professor of practice at Wharton and a Senior Global Fellow at the Lauder Institute. He serves on two corporate boards and several advisory committees and nonprofit boards. Prior to PIMCO, Dr. El-Erian was a Managing Director at Solomon Smith Barney/Citigroup in London. And before that, he spent 15 years at the International Monetary Fund in Washington, D.C., where he served as Deputy Director before moving to the private sector. He also spent two years as CEO and President of the Harvard Management Company. He's a graduate of Cambridge University and he has Master's and PhD from Oxford.

So Mohamed, I went back two years ago right now, and you were on CNBC and you said, "I'm not in the camp that a recession is 100% probability, but I am in the camp that the probability of recession is uncomfortably high." And then you went on to say the probability of a soft landing is "meager". So here we are two years from then. And the uncomfortably high probability didn't happen and seems to be that the meager outcome has actually happened. When we were together six months ago, you had a probability chart. It was actually -- it was wonderful. It was a multimodal distribution, which, as you described to all of us, is very difficult for humans to look at and sort of, if you will, not only analyze but have conviction around. But on that chart, you had the chance of a recession at 35%, the chance of a soft landing at 50%, and the chance of a better than soft landing at about 15%. Where do you stand today on that distribution as it relates to the chances of recession, soft landing, or even better?

Thank you for having me. So the good news is the 35% probability of recession has not happened, and the 65% of something better is what has prevailed. What's even more interesting is that we really haven't had a soft landing. We've had a no landing. Growth has remained robust. Inflation has gotten sticky so we're not back to the 2%. In fact, the Fed itself has acknowledged that, once again, it has been confounded by what has happened to inflation. So we are living in this no-landing scenario where growth is robust, hasn't reacted to what has been a significant increase in interest rates. Inflation has stopped coming down. The markets have repriced Fed cuts. The markets not only expect 1 to 2 cuts this year, we may get even less than that. So we are in this world of economic exceptionalism. And I say that because compared to Europe, compared to other countries, we are doing extremely well and we continue to surprise on the upside.

Let's dive in a little bit there on a number of things that you just said. So on the inflation being sticky, we've seen inflation come down. Last I heard you speak about this, you said that we're probably going to be at 2.5% to 3% and that the Fed will be sort of accepting of that higher range. An area of inflation that's obviously very important to me and Walker & Dunlop and our clients is shelter. And it appears that with the oversupply in both single as well as multifamily in 2024 leading into '25, that prices have come down, rent inflation, if you will, rents have come down, single-family housing prices have come down. Given the amount in the CPI that is shelter, if that continues to move down materially, isn't that going to get you below that target range that you said of 2.5% to 3%?

We'd hope so. I don't think we're going to get there and I think more economists are recognizing that. Look, step back, the big bet was that we would get softest services inflation, softest housing inflation, while goods were outright in disinflation. And by the time goods reversed and started inflating again because prices can't go down forever, then you would get to 2%. That was the big bet. It turns out that services in particularly are very sticky. And we continue to get indicators that the service sector is very strong. So you're not going to get enough disinflation from the service side before the goods side becomes less accommodating. That is the problem. Look, it's not an issue because, as you know when we discussed this, I argued that if we were to establish an inflation target today, we wouldn't choose 2%. Structurally, we would go for a higher target of 2.5% to 3%. 2.5% to 3% is fine. It's stable. It doesn't de-anchor inflation expectations. The problem is that the Fed cannot explicitly change its inflation target because it has missed it for so long. So the hope and I hope that they do that is they simply keep on pushing it back, just keep on pushing it back saying we'll get there eventually and tolerate a somewhat higher inflation rate because the alternative of hiking interest rates would be very bad news for the economy.

So there's -- just talking about hiking interest rates. There's a -- I have a -- they got something from JPMorgan. Michael Cembalest is an incredible economist and they sent this out. And in this analyst report called The Alchemist, which he put together at the end of the year, they looked at the 10-year treasury 65 days after the first rate cut, and they looked at it in 7 examples. And in 5 of the 7, the 10-year was down, 65 days after the first rate cut, somewhere between 40 and 60 basis points. In one instance, I think it was in -- sorry, 1998, the 10-year had actually gone up by 10 basis points. But this time, we're up 90 basis points, wholly just kind of off the charts as it relates to an anomaly. Talk for a moment, Mohamed, why we're getting this sort of, if you will, adverse or inverse reaction to rate cuts right now in the 10-year bond.

So part of it is initial conditions. We didn't start this a normal situation. We started it from a situation where the Fed had been buying a lot of bonds. Interest rates were artificially low. And we've had a combination of the Fed being late in raising interest rates so having to raise interest rates really quickly. And QE, quantitative easing, when the Fed buys bonds and, therefore, puts downward crush on yields becoming QT, quantitative tightening, where they're reducing their balance sheet. So the initial conditions were completely different. That's the first issue. The second issue is the economy has proven really strong. The economy has proven almost immune to rate hikes. Certain sectors like yours is not immune. But if you look at other sectors, it's done extremely well. And part of that is because corporations got ahead of the interest rate increases by prefunding a lot of their needs. So that didn't hit. And then the third issue, it has to do with just the dynamics of inflation and the Fed not understanding the dynamics of inflation once again. So we have this very peculiar situation where the 10-year, like you said, has gone up. And I think that if we look for this year, it would not surprise me if for most of the year, we average 4.75% to 5% for the 10-year, which would be quite high, given that like you said, historically, the 10-year goes down in a cutting cycle, doesn't go up.

And are you playing that? If that's your rate range, if you will, from 4.50%, 4.75% to 5%, is that slowing down the growth because if you think about it in the sense of PE multiples and where the market is, and we'll get to that in a second, are you playing that into that, that is going to put downward pressure on growth in the year? Or where are you on GDP growth? Are you still at a 2.5% to 3% GDP growth for '25?

So I am where I was but slightly lower on growth, the same where I was on inflation, but there was a big uncertainty. And that is the incoming Trump administration has signaled policy intentions in three areas: one is tariffs; two is repatriation of illegal immigrants and therefore, a labor force issue; and three is our fiscal. So depending on where these things go, that's going to have a huge impact, especially on the inflation side of that equation.

And just talk about that for a second. I've heard you talk about sort of the two effects of the new administration coming in, where you have deregulation and growth on one side, and then you have a potential unsettling of the labor markets and then tariffs on the other side. And you sort of have teed it up that there's sort of a, if you will, there's going to be a battle between those two things and which one actually wins is going to have a big impact on the overall economy. Given the things you've seen and heard from the incoming administration, you think the growth and the deregulation efforts actually act to stimulate the economy more? Or do you think that the tariffs and the labor disruption end up bringing it down where it's a net negative versus net positive?

Well, I think of it as a race. And if you ask me who's going to win the race at the end, it will be the deregulation, the liberalization and what that does to productivity, what does that -- what it does to growth. So if you ask me, think of it as a 400 meters, who's going to win the 400 meters race? In my mind, undoubtedly, is the deregulation side. But in the first 100 meters and maybe the first 200 meters, depending on what happens on tariffs, the other side may be in the lead. So there's a time and consistency aspect because you cannot move as quickly on all that President Trump wants to do on the wheel economy as you can on tariffs. And I suspect that we will get tariff announcements pretty quickly. At the end of the day, and this is now me guessing because it really is a decision of one person, I suspect tariffs will be particularly problematic for China. They'll be less problematic for Europe and for Mexico and Canada. So at the end of the day, countries will offer something to the Trump administration to make sure that we don't get a massive tariff shock.

Let's talk for a moment about deregulation because there was a very interesting analysis that was done by the American Action Forum back in April, a gentleman named Doug Eakin, where they calculated the total cost of the final rules done by administration from the Obama administration to the Trump administration, the Biden administration. And there were a couple of stats, Mohamed, that just jumped out at me, which I think do speak to your point as it relates to how the markets will react to the deregulation that is coming in from a Trump administration. The total cost of the final rules by administration calculated by the American Action Forum under Obama, $1.1 trillion; by Trump, $25 billion; and by Biden, $1.38 trillion. So Biden took the increased regulation from the Obama administration, took it to a whole different level as it relates to the cost of the rules that were in place. And they also just getting heads around trillions of dollars of regulatory hurdles and burdens is a little difficult to do. They also calculated in paperwork hours. And I actually, yesterday, filled out my SEC Board annual survey as it relates to any conflicts that might have. I'm assuming you've just done it for your two publicly traded Boards recently. And I'm sitting there with 30 pages of questions that go all over any possible conflict that I may have being on the Board of Walker & Dunlop. But in paperwork hours calculated by millions of hours, the Obama administration rules added 240 million hours. The Trump administration last time 60 million, and the Biden administration, again, taking the Obama administration to a whole different level, 260 million hours of additional paperwork added by the rules that were passed by the Biden administration. So you've got to think that just any kind of reversion to where Trump was at somewhere in -- I don't know what that -- what is that? That's less than 20% of the regulatory burden that was passed by the Obama administration and the Biden administration will be massively helpful to the overall markets, no?

That's how the markets have reacted, and it's not just the government. We're also seeing a change in the Federal Reserve, where the market expects that this will unleash the banking sector even more. So certainly, the markets are pricing in a significant impact on growth. And there's something else that you and I have talked about in the past, which is that we are seeing transformational changes in technology and life sciences. And then we're also seeing forced changes in defense, in health care. And those tend to have significant positive productivity effects. So if we can manage through the next 18 months, what comes thereafter is activity-enhancing and growth-enhancing, but we've just got to manage through the next 18 months.

So I've heard you talk about change. I actually went back and watched the video you did on a TEDx speech you gave back in 2013. And you were talking about change in financial services and about the need for not necessarily to understand the why, but the what, in the sense of what are you going to do to change and get your organization ready for the type of change. Talk for a moment, because you've been in so many scaled organizations that have had to deal with not only changing markets, but the advent of new technology. Is today, Mohamed, in your view, wholly different from the technological changes that came in with the advent of the Internet, the changes that came into the financial services markets back in the early 2012, 2013, over the last decade? Is this something that companies that you work with and see today, is this wholly different to the point where you literally have to stop everything and say, "Hold it. This is not the type of thing where you can just sort of evolve into the change, but you must dramatically change how you actually do what you do on a day-to-day basis."

Yes. And you said the important word there, how? Most of the time, it impacts what you do. This impacts how you do it, and in particular, artificial intelligence. I see this in education. I see it in health. We are just at the beginning of a fundamental change in how we do things. And the question I ask people when they say to me, "Well, how should I think about that?" I say, "Ask yourself the following question. If I were born an AI-native company, how would I be different?" And force yourself, you're not going to become AI-native. It takes a really long time, but force yourself to go through the thought exercise of what -- how would you look if you were born AI-native, if you didn't have all the legacy issues that we do? It's quite striking how different the world looks when you ask that question. And I do think that this transformation, which I do not believe is overhyped at all, is going to create leaders and laggards, and it's going to be fundamentally a different landscape in 5 to 10 years. I really do think that this is a structural break that's going on in the way we do things. And it's not just corporations. It is individuals, it is governments and it also impacts how they react. And you heard me say, it's the 80-20, 80% is good, 20% is bad. And you shouldn't get carried away with either the 80% or the 20%. You should embrace the 80% and the 20% and ask yourself, how do I unleash the 80% and how do I contain the 20%? Because the 20% that is bad can be pretty bad.

I want to loop back to the 80-20 in a second. I've got one other thing I want to talk about on AI before we go back to talk about Europe and the U.S. But one of the things I thought was so interesting of you saying was you look at the way that the U.S. is focused on AI, they're focused on the 80% of the good and the EU is 100% focused on the 20% that is bad. And that's just showing you the investments and the returns that they're both going to get from, which I thought was a very interesting, and we'll talk about Europe versus U.S. exceptionalism in the second. But on AI, Mohamed, one of the things that a lot of people have been a little concerned about is the amount of CapEx investing that is going into data centers and the hyperscalers, the analysis that Cembalest has in his JPMorgan report, is that right now with the CapEx spending of the hyperscalers, you could power 12,000 ChatGPTs, 12,000 ChatGPTs with the amount of capacity we have today in data centers for AI usage. So is there a chance, and he goes and talks about Corning at the turn of the millennium and the fact that Corning at that time, when everyone was talking about broadband and fiber optics, that there was this massive investment in it, and Corning's revenues got to $4 billion in 2000 and that on real terms, Corning's revenues have never gotten back to $4 billion. And that they -- since then, they just got oversupply of fiber optic networks, and therefore, it's never actually caught up with the capacity we build. Do you at all get concerned that we're building too much capacity on the AI front right now?

Look, this overall reaction is part of the process, and it's actually what makes this process a big enabler. You can look back at fiber optics, you can look back at securitization in finance. You can look back at the steam engine. The minute an innovation is perceived to lower the barriers to both producing it and using it, so whatever it is, you get overconsumption and overproduction. And that is part of the cycle of innovation that you suddenly lower the barriers to entry for a certain activity. People rush in, that's what we do. There is excessive buying, there's excessive production and then the system has a second round where it shakes off that. I would rather go through this than what's happening in Europe right now, which is very little. I think if you look at the cost benefit, it is much better to go in there. Look, you and I have discussed this in the past. What are the enablers of this AI revolution? One is data. You have -- there's a lot of data that isn't being used. Two is expertise. Three is energy, and four is computing power. Those are the four things that allow this. And are we going to have excesses? Sure we are. But at the end of the day, we will be in a better place than Europe than China. And that's important because this is a transformational change.

So you mentioned energy. WTI crude is what closed yesterday at $74.22. That's the highest price in the last three months. So here, we have an incoming administration that literally got elected on a theme of drill, drill, drill, and markets are supposed to look forward, not backwards. And so how is it, Mohamed, that we have WTI crude at $74 bucks a barrel right now with an incoming administration that is looking to open up and produce more electricity in the United States, more I should say, more oil, more natural gas and derivatives from that over the next four years?

Two reasons: one is OPEC+ is controlling supply and Saudi Arabia, in particular, is producing well below capacity to protect price. But there's something else going on, which is geopolitics. If you're in the marketplace, you have to price in some probability, as low as it is, some probability of, and I'll give you a potential scenario. Right now, Iran has very few air defenses. Israel could be tempted to go after the nuclear facilities in Iran. There was a possibility, I'm not saying a probability, a possibility that Iran responds by blocking the straits of Hormuz. And next thing you know, oil is at $100 or $150. Now is that a high probability event? No, but it's an impactful event. So there's this geopolitical cloud that's hanging over the energy market that results in a price that's much higher than what would be warranted by the demand side. Because the demand side isn't that strong right now because of what's happening in China and what's happening in Europe. So for me, it's not surprising that between OPEC+ controlling production and this geopolitical cloud that's still there, that we're seeing prices in the $70s.

Interesting thing that you pointed out the shutting down of the straits because I thought you were going to say, "Well, we could lose Iran's oil production if Israel were to invade them," but that's only 2 million barrels a day or something so that's not going to move world prices. But to your point, if they were to do something to disrupt the trade of oil, that obviously has much broader implications than just Iran production coming off-line.

Right. And it's not that hard to block the straits, right? I mean, I remember we used to be talked about a lot in the past, and we've forgotten about it because this American exceptionalism has acted as a shield as an incredible shield against very messy geopolitics. If you compare to when you and I discussed it in the summer, Russia had gotten an upper hand over Ukraine in that war. The conflict in the Middle East has continued and has spread. It has spread to Lebanon, it has spread to Iran, it has spread to Yemen. And we're seeing how fragile some of the countries out there of with what happened in Syria. So geopolitically, the situation has gotten messier than when we last spoke. And yet, we've had this shield that has protected markets and has protected the economy from this messy geopolitics.

One other thing on energy before we go to U.S. exceptionalism. I've heard you say the good, the bad, and the ugly. Good U.S., bad Europe and -- no, bad China, ugly Europe. I want to get to that in a second. But on energy, one of the other things that I've read, Mohamed, I'd love your thoughts on it is just that we have increased oil production in the United States so dramatically that there isn't a huge amount of additional gains that can be had by this drill, drill, drill policy by the Trump administration. The numbers are that back from 2000 to 2010, we, in the United States, of crude, natural gas and natural gas liquids, we're producing around 3 trillion BTUs per month. That then stepped up to 5 trillion BTUs per month from '14 to '18. And in 2024, we're producing 7 trillion BTUs per month. So our oil and natural gas production have just gone up so much. And then Biden is about to, I believe, sign an executive order that is going to ban drilling in the Atlantic as well as the Pacific. And it's one of those executive orders going back to the 1953 Outer Continental Shelf Agreement, something like that, that is going to be very difficult for Trump to come in and turn over. Do you think that's having some impact here? Or do you think that the Atlantic and the Pacific drilling is a minor issue as it relates to just the general Trump theme? And it's much more of the global political, geopolitical issues than it is U.S. domestic oil policy and not being able to find increased returns?

I think it's more the global issues than the U.S. issues. I mean, it is incredible that the U.S. now is not only the major producer, but we have basically replaced Russia in LNG exports to Europe. I mean, it is amazing how Europe is dependent now on U.S. LNG to replace what it lost in Russia. So if I look at the U.S. in the energy equation, it is totally dominant. And on balance, I expect it will become more dominant going forward. But we also had to deal with the fact that there are OPEC+ producers. We also have to deal with the fact that markets need to price something for tail risk. You can't completely ignore a tail risk. So I think that's where we are. It is -- for me, the most amazing sign of the energy is the demand side because had people projected the weakness in Europe and the weakness in China, they would have projected much, much lower oil prices. And you're just striking that oil prices have remained there, and again, it's because of the supply side.