10-K 1 d521870d10k.htm 10-K 10-K
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

(Mark One)

  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2017

OR

 

  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from             to             

Commission file number: 001-33280

HFF, INC.

(Exact name of registrant as specified in its charter)

 

Delaware    51-0610340
(State of incorporation)   

(I.R.S. Employer

Identification No.)

One Victory Park

2323 Victory Avenue, Suite 1200

Dallas, Texas 75219

   (214) 265-0880

(Address of principal executive offices,

including zip code)

  

(Registrant’s telephone number,

including area code)

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

 

Name of Exchange on Which Registered

Class A Common Stock, par value $.01 per share   New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:

NONE

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ☐    No  ☑

Indicate by checkmark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ☐    No  ☑

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 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  ☑    No  ☐

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  ☑    No  ☐

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ☐

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

 

  Large accelerated filer                  Accelerated filer                  Non-accelerated filer                  Smaller reporting company  
                          Emerging growth company  
                          (Do not check if a smaller reporting company)

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

Indicate by checkmark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).    Yes  ☐    No  ☑

As of February 20, 2018, there were 38,726,900 shares of Class A common stock, par value $0.01 per share, of the registrant outstanding.

The aggregate market value of the registrant’s voting stock held by non-affiliates at June 30, 2017 was approximately $1.3 billion, based on the closing price per share of Class A common stock on that date of $34.77 as reported on the New York Stock Exchange. Shares of common stock known by the registrant to be beneficially owned by directors and officers of the registrant subject to the reporting and other requirements of Section 16 of the Securities Exchange Act of 1934 are not included in the computation. The registrant, however, has made no determination that such persons are “affiliates” within the meaning of Rule 12b-2 under the Securities Exchange Act of 1934.

DOCUMENTS INCORPORATED BY REFERENCE

Selected portions of the Proxy Statement for the 2018 Annual Meeting of Stockholders are incorporated by reference into Part III of this Report.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

PART I

  

Item 1.

  Business      1  

Item 1A.

  Risk Factors      10  

Item 1B.

  Unresolved Staff Comments      24  

Item 2.

  Properties      24  

Item 3.

  Legal Proceedings      24  

Item 4.

  Mine Safety Disclosures      24  

PART II

  

Item 5.

  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities      25  

Item 6.

  Selected Financial Data      27  

Item 7.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      29  

Item 7A.

  Quantitative and Qualitative Disclosures About Market Risk      48  

Item 8.

  Financial Statements and Supplementary Data      49  

Item 9.

  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure      84  

Item 9A.

  Controls and Procedures      84  

Item 9B.

  Other Information      84  

PART III

  

Item 10.

  Directors, Executive Officers and Corporate Governance      85  

Item 11.

  Executive Compensation      85  

Item 12.

  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      85  

Item 13.

  Certain Relationships and Related Transactions, and Director Independence      85  

Item 14.

  Principal Accountant Fees and Services      85  

PART IV

  

Item 15.

  Exhibits and Financial Statement Schedules      86  

Item 16

  Form 10-K Summary      88  
 

Signatures

     89  

 

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FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K contains “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended. These forward-looking statements reflect our current views with respect to, among other things, our operations and financial performance. You can identify these forward-looking statements by the use of words such as “outlook,” “believes,” “expects,” “potential,” “continues,” “may,” “will,” “should,” “seeks,” “approximately,” “predicts,” “intends,” “plans,” “estimates,” “anticipates” or the negative version of these words or other comparable words. Such forward-looking statements are subject to various risks and uncertainties. Accordingly, there are or will be important factors that could cause actual outcomes or results to differ materially from those indicated in these statements. We believe these factors include, but are not limited to, those described under the caption “Risk Factors” in this Annual Report on Form 10-K. These factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included in this Annual Report on Form 10-K. We undertake no obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise, except as required by securities laws.

SPECIAL NOTE REGARDING THE REGISTRANT

In connection with our initial public offering in February 2007, we effected a reorganization of our business into a holding company holding the partnership interests in Holliday Fenoglio Fowler, L.P. and HFF Securities L.P. (together, the “Operating Partnerships”), held through the wholly-owned subsidiary HFF Partnership Holdings, LLC, a Delaware limited liability company and all of the outstanding shares of Holliday GP Corp. (“Holliday GP”), the sole general partner of each of the Operating Partnerships. The transactions that occurred in connection with the initial public offering and reorganization are referred to as the “Reorganization Transactions.”

Unless the context otherwise requires, references to (1) “HFF Holdings” refer solely to HFF Holdings LLC, a Delaware limited liability company that was previously the holding company for our consolidated subsidiaries, and not to any of its subsidiaries, (2) “HFF LP” refer to Holliday Fenoglio Fowler, L.P., a Texas limited partnership, (3) “HFF Securities” refer to HFF Securities L.P., a Delaware limited partnership and registered broker-dealer, (4) “Holliday GP” refer to Holliday GP Corp., a Delaware corporation and the general partner of HFF LP and HFF Securities, (5) “HoldCo LLC” refer to HFF Partnership Holdings LLC, a Delaware limited liability company and a wholly-owned subsidiary of HFF, Inc., (6) “Holdings Sub” refer to HFF LP Acquisition LLC, a Delaware limited liability company and wholly-owned subsidiary of HFF Holdings, (7) “HFF Real Estate” refer to HFF Real Estate Limited, a company incorporated in England and Wales and (8) “HFF Securities Limited” refer to HFF Securities Limited, a company incorporated in England and Wales and registered with the Financial Conduct Authority (collectively, with HFF Real Estate, the “UK Subsidiaries” and collectively with HFF Securities, the “Securities Subsidiaries”). Except where specifically noted, references in this Annual Report on Form 10-K to “the Company,” “we”, “our”, or “us” mean HFF, Inc., a Delaware corporation and its consolidated subsidiaries after giving effect to the Reorganization Transactions.

 

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PART I

Item 1.    Business

Overview

We are, based on transaction volume, one of the leading providers of commercial real estate and capital markets services to both the consumers and providers of capital in the commercial real estate industry and one of the largest full-service commercial real estate financial intermediaries in the country. We operate out of 26 offices with approximately 982 associates including approximately 371 capital markets advisors. During 2017, we advised on approximately $96.1 billion of completed commercial real estate transactions, a 17.1% increase compared to the approximately $82.0 billion of completed transactions we advised on during 2016.

Our fully-integrated national capital markets platform, coupled with our knowledge of the commercial real estate markets, allows us to effectively act as a “one-stop shop” for our clients, providing a broad array of capital markets services including:

 

   

Debt placement;

 

   

Investment advisory;

 

   

Distressed debt and real estate owned advisory services;

 

   

Equity placement;

 

   

Investment banking and advisory services;

 

   

Loan sales; and

 

   

Commercial loan servicing.

Substantially all of our revenues are in the form of capital markets services fees collected from our clients, usually negotiated on a transaction-by-transaction basis. We also earn fees from commercial loan servicing activities. We believe that our multiple product offerings and platform services, diverse client mix, expertise in a wide range of property types and national platform have the potential to create a diversified revenue stream within the commercial real estate sector. Our revenues and net income were $609.5 million and $95.0 million, respectively, for the year ended December 31, 2017, compared to revenues and net income of $517.4 million and $77.2 million, respectively, for the year ended December 31, 2016.

We have established strong relationships with our clients. Our clients are both consumers of capital, such as property owners, and providers of capital, such as lenders and equity investors. Many of our clients act as both consumers and providers of capital in different transactions, which enables us to leverage our existing relationships and execute multiple transactions across multiple platform services and product offerings with the same clients.

We believe we have established a reputation for high ethical standards, dedicated teamwork and a strong focus on serving the interests of our clients. We take a long-term view of our business and client relationships, and our culture and philosophy are firmly centered on putting the clients’ interests first.

During 2017, we continued to grow our business through expanding our service offerings within our existing offices as well as strategic hires and acquisitions. In January 2017, we launched our operations in the United Kingdom (“UK”) upon completion of an acquisition in London. Our UK business offers a full spectrum of commercial real estate capital markets transaction services including investment banking/corporate finance, investment transactions and debt and equity placement. Additionally, in March 2017, the Company acquired an entity in New York providing mergers and acquisitions and corporate advisory services.

 

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We operate in the commercial real estate market which is inherently cyclical. We have benefited from the current economic cycle which began after the downturn in late 2007 continuing through 2010. During the downturn, restrictions on the availability of both debt and equity capital created significant reductions of liquidity in, and flow of capital to, many global financial markets including the commercial real estate financial markets in the U.S. Although there is no way to predict the end of the current economic cycle, we currently maintain significant levels of cash in an effort to mitigate risks associated with an economic downturn. Further detail regarding the effect of the recent situation in the credit markets and the commercial real estate markets can be found under the headings “Risk Factors” and “Management’s Discussion and Analysis of Financial Conditions and Results of Operations” in this Annual Report on Form 10-K.

HFF, Inc. is a Delaware corporation with its principal executive offices located at 2323 Victory Avenue, One Victory Park, Suite 1200, Dallas, Texas, 75219, telephone number (214) 265-0880.

Reportable Segments

We operate in one reportable segment, the commercial real estate financial intermediary segment, and offer debt placement, investment advisory, distressed debt and real estate owned advisory services, equity placement, investment banking and advisory services, loan sales and commercial loan servicing. See “Results of Operations” within Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a discussion of our results.

Our Competitive Strengths

We attribute our success and distinctiveness to our ability to leverage a number of key competitive strengths, including:

People, Expertise and Culture

We and our predecessor companies have been in the commercial real estate business for over 30 years, and our capital markets advisors have significant experience and long-standing relationships with our clients. We employ approximately 371 capital markets advisors with an average of 17.2 years of commercial real estate transaction experience. The transaction history accumulated among our capital markets advisors ensures a high degree of market knowledge on a macro level, knowledge of commercial real estate markets, long term relationships with the most active investors and a comprehensive understanding of commercial real estate capital markets products. Our employees come from a wide range of real estate related backgrounds, including investment advisors and managers, investment bankers, attorneys, brokers and mortgage bankers.

Our culture is governed by our commitment to high ethical standards, putting the clients’ interests first and treating clients and our own associates fairly and with respect. These distinctive characteristics of our culture are highly evident in our ability to retain and attract employees. The average tenure for our senior capital markets advisors is 14.8 years, and the average production tenure for the top 25 senior capital markets advisors compiled by initial leads during the last five years was 17.2 years (including tenure with predecessor companies). Furthermore, several of our senior capital markets advisors have a personal economic interest in our firm, which further aligns their individual interests with those of the Company and its stockholders, as a whole, and our clients.

Integrated Capital Markets Services Platform

In the competitive commercial real estate and capital markets industry, we believe one of our key differentiators is our ability to analyze all commercial real estate product types and markets as well as our ability to provide clients with comprehensive analysis, advice and execution expertise on all types of debt and equity capital markets solutions. We believe that due to our broad range of execution capabilities, our clients rely on us

 

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not only to provide capital markets alternatives but, more importantly, to advise them on how to optimize value by uncovering inefficiencies in the non-public capital markets to maximize their commercial real estate investments. We believe our capabilities provide our clients with the flexibility to pursue multiple capital markets options simultaneously so that, upon conclusion of our efforts, they can choose the best risk-adjusted solution.

Independent Objective Advice

Unlike many of our competitors, we do not currently offer services that compete with services provided by our clients such as leasing or property management, nor do we currently engage in principal capital investing activities which would compete with a number of our clients. We believe this allows us to offer independent objective advice to our clients. We believe our independence distinguishes us from our competitors, enhances our reputation in the market and allows us to retain and expand our client base.

Extensive Cross-Selling Opportunities

As some participants in the commercial real estate market are frequently buyers, sellers, lenders and borrowers at various times, we believe our relationships with these participants across all aspects of their businesses provide us with multiple revenue opportunities throughout the life cycle of their commercial real estate investments. In addition, we sometimes provide more than one service in a particular transaction, such as in an investment sale where we not only represent the seller of a commercial real estate investment but also represent the buyer in arranging acquisition financing. During 2017, 2016 and 2015, we executed numerous transactions across multiple platform services with 23, 22 and 24, respectively, of our top 25 clients.

Broad and Deep Network of Relationships

We have developed broad and deep-standing relationships with the users and providers of capital in the industry and have completed multiple transactions for many of the top institutional commercial real estate investors in the U.S. as well as several global investors who invest in the U.S. Importantly, our capital markets advisors, analysts and closing specialists foster relationships with their respective counterparts within each client’s organization. This provides, in our opinion, a deeper relationship with our firm relative to our competitors. In 2017 and 2016, no one borrower or no one seller client, represented more than 4% of our total capital markets services revenues. The combined fees from our top 10 seller clients for the years 2017 and 2016, were less than 10% of our capital markets services revenues for each year, and the combined fees from our top 10 borrower clients were less than 6% of our capital markets services revenues for each year.

Proprietary Transaction Database

We believe that the extensive volume of commercial real estate transactions that we advise on throughout the U.S. and across multiple property types and capital markets service lines provides our capital markets advisors with valuable, real-time market information. We maintain a proprietary database of numerous current and potential capital sources and clients that tracks key terms and provisions of the majority of all closed and pending transactions in which we are involved. This proprietary database also includes historical and current flows and the pricing of debt, structured finance, investment advisory, loan sales and equity transactions. The database maintains real-time quotes and bids on pipeline transactions, status reports on all current transactions as well as historical information on clients, lenders and buyers. Furthermore, our internal databases maintain current and historical information on our loan servicing portfolio, which we believe enables us to track real-time property level performance and market trends. These internal databases are updated regularly and are available to our capital markets advisors, analysts and other internal support groups to share client contact information and real-time market information. We believe this information strengthens our competitive position by enhancing the advice we provide to clients and improving the probability of successfully closing a transaction. We believe our associates also understand the confidential nature of this information, and if it is misused, depending on the circumstances, such misuse can be cause for immediate dismissal from the Company.

 

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Our Strategic Growth Plan

We seek to improve our market position by focusing on the following strategic growth initiatives:

Increase Market Share Across Each of our Capital Markets Services

We believe that we have the opportunity to increase our market share in each of the various capital markets services we provide to our clients by penetrating deeper into our international, national, regional and local client relationships. We also intend to increase our market share by selectively hiring capital markets advisors in our existing offices and in new locations, predicated on finding the most experienced professionals in the market who have the highest integrity, work ethic and reputation, while fitting into our culture and sharing our business philosophy and business practices. Since 2011, we have opened offices in Phoenix, AZ, Tampa, FL, Austin, TX, Denver, CO, Orlando, FL, Philadelphia, PA, Charlotte, NC, London, UK, Seattle, WA, and Las Vegas, NV. We have also significantly added to the platform services and product specialty types in a majority of our offices.

 

   

Debt Placement.    In 2017, our transaction volume in debt placements was approximately $51.7 billion, an increase of 27.2% from approximately $40.7 billion in 2016.

 

   

Investment Advisory.    In 2017, we completed investment advisory services of approximately $34.5 billion, a decrease of approximately 5.9% from the approximately $36.7 billion completed in 2016. According to Real Capital Analytics, commercial real estate sales volume for office, industrial, multifamily, retail, hotel properties and land in the U.S. in 2017 and 2016 were $467.5 billion and $495.3 billion, respectively.

 

   

Equity Placement and Advisory Services.    In 2017, we completed approximately $9.3 billion of equity placement and advisory services transactions (which include amounts that we internally allocate to the equity placement reporting category, even though the transaction may have been funded through a single mortgage note) for our clients, representing an increase of 131.3% from the $4.0 billion completed in 2016.

 

   

Private Equity and Investment Banking and Advisory Services.    Our Securities Subsidiaries, undertake private equity capital raises, investment banking activities and asset-level transactions for our clients. At December 31, 2017 and 2016, our Securities Subsidiaries were engaged with $1.8 billion and $2.8 billion, respectively, of active private equity discretionary fund transactions, which may result in additional future revenue.

 

   

Loan Sales.    We have consummated $0.6 billion and $0.7 billion in loan sales transactions in 2017 and 2016, respectively, a decrease of 18.0%. This business is based on the desire of lenders seeking to diversify concentration risk (geographic, borrower or product type), manage potential problems in their loan portfolios or sell loans rejected from commercial-mortgage backed securities (CMBS) securitization pools.

 

   

Commercial Loan Servicing.    The principal balance of HFF’s loan servicing portfolio increased 20.5% to approximately $69.8 billion at December 31, 2017 from approximately $58.0 billion at December 31, 2016. We currently have approximately 35 correspondent lender relationships with life insurers.

While the volume increases relating to our debt placement, equity placement and advisory services and loan servicing services referenced above were principally the effect of improved market conditions and increased activity in the commercial real estate market, we believe that our efforts to open new offices and expand our platform services and product specialties have also aided us in our achievements.

Continue to Capitalize on Cross-Selling Opportunities

Participants in the commercial real estate market increasingly are buyers, sellers, lenders and borrowers at various times. We believe our relationships with these participants across all aspects of their businesses provide

 

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us with multiple revenue opportunities throughout the life cycle of their commercial real estate investments. Many of our clients are both consumers and providers of capital, and our goal is to attempt to work with our clients to execute transactions utilizing the wide spectrum of our services. By maintaining close relationships with these clients, we believe we will continue to generate significant repeat business across all of our business lines.

Our debt capital markets advisors originated approximately $8.2 billion and $7.0 billion of debt for clients that purchased properties sold by our investment advisory capital markets advisors for their clients in 2017 and 2016, respectively. Our investment advisory capital markets advisors also referred clients to our debt capital markets advisors who arranged debt financings totaling approximately $9.7 billion and $6.1 billion in 2017 and 2016, respectively. Our debt capital markets advisors also referred clients to our investment advisory capital markets advisors who sold approximately $3.7 billion and $4.7 billion of properties in 2017 and 2016, respectively. Also, in 2017 and 2016, our Securities Subsidiaries originated debt volumes of approximately $1.7 billion and $273.0 million, respectively, in addition to its other equity placement activities.

Expand Our Geographic Footprint

We believe that opportunities exist to strategically establish and increase our presence in several key domestic and international, markets. When strategic opportunities present themselves with high-quality capital markets advisors, it is our intention to capitalize on such opportunities as we did in Seattle, WA and London, UK in 2017, Phoenix, AZ in 2016, Charlotte, NC in 2014, Philadelphia, PA in 2013, Orlando, FL in 2012 and Denver, CO in 2012. While our capital markets advisors, located in 26 offices (25 throughout the U.S. and one in the UK), advised clients on transactions in 44 states, the District of Columbia, Canada, and the United Kingdom and in more than 775 cities in 2017, there are a number of major metropolitan areas where we do not maintain an office. In addition to the 2017 opening of an office in London, UK, we do, on a periodic basis, send our capital markets advisors overseas to meet with capital sources and global clients. By comparison, a number of our large public competitors have in excess of 100 offices worldwide and some have nearly 100 in the U.S alone. We constantly review key demand drivers of commercial real estate by market, including growth in population, households, employment, commercial real estate inventory by product type, and new construction. By doing so, we can determine not only where future strategic growth should occur, but more importantly, we can also ensure our capital markets advisors are constantly calling on the most attractive markets where we do not have offices. Since 2011, we have opened nine new offices, and during this same period, we have significantly added to the platform services and product specialties in nearly all of our offices. See “Results of Operations” within Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a discussion of the results of our U.S. operations and “Risks Related to Our Business” within Item 1A, “Risk Factors” for a description of risks associated with our business, including with respect to operations in the United Kingdom.

We expect to achieve future strategic geographic expansion through a combination of recruitment of key capital markets advisors, organic growth of analysts to capital markets advisors and possible acquisitions of smaller local and regional firms across all services in both new and existing markets as well as the possible expansion into other platform lines of business and product specialties. However, in all cases, our strategic growth will be focused on serving our clients’ interests and predicated on finding the most experienced professionals in the market who have the highest integrity, work ethic and reputation, while fitting into our culture and sharing our business philosophy and business practices.

Align our Leadership and Compensation Structures with Our Long-term Growth

We manage our operations through an executive committee (including ad-hoc members) and a leadership committee which includes in excess of 70 of our senior capital markets advisors and managers. The executive committee consists of at least three, but no more than seven, individuals (in addition to ad-hoc members), one of whom is the managing member of the Operating Partnerships. The executive committee currently consists of our two inside directors, Mark Gibson, our chief executive officer, and Jody Thornton, our president and managing

 

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member of the Operating Partnerships, and five of our executive managing directors, Matthew D. Lawton, Gerard T. Sansosti, Manuel A. de Zarraga, Michael J. Tepedino, and effective January 1, 2018, Kevin MacKenzie. The executive committee is primarily responsible for the day-to-day oversight of the lines of business and property verticals. The leadership committee is composed of (i) the executive committee members, (ii) individual leaders chosen from each line of business and property vertical, (iii) the office heads from each office and (iv) individuals from other line and support functions at the discretion of the executive committee. The members of the leadership committee are responsible for either overseeing their respective lines of business, property verticals or their office as well as facilitating communication and educating all of our capital markets advisors within each office, line of business, property type and product specialties to better serve our clients.

We also aim to ensure continued emphasis on annual production, maintain our partnership culture and continue the alignment of employee, management and stockholder interests through periodic omnibus awards to individuals and through our profit participation bonus plans. Under our HFF LP and HFF Securities profit participation bonus plans, (collectively, the “Office Profit Participation Plans”) with respect to each applicable office for each calendar year, if a 14.5% or greater profit margin is generated by such office, an amount equal to 15% of the adjusted operating income (as defined under such plan) generated by such office funds a cash bonus pool payable to selected employees of HFF LP or HFF Securities, as the case may be. These plans were adopted in 2007 in connection with our initial public offering. Effective January 1, 2015, we amended the Office Profit Participation Plans to provide that our board of directors, or any appropriate committee thereof, may elect to pay up to one-half of the profit participation bonuses payable under the plans in the form of equity-based awards. In December 2010, we also adopted a new HFF, Inc. firm profit participation bonus plan (the “Firm Profit Participation Plan”) utilized primarily to compensate our business line and property vertical leadership. Under this plan, for each calendar year, if we achieve a 17.5% or greater adjusted operating income margin (as defined under such plan), a bonus pool will be funded by a percentage, ranging from 15% to 25%, of our adjusted operating income (as defined under such plan) beyond predefined adjusted operating income margin thresholds. Our board of directors, or an appropriate committee thereof, may elect to pay up to two-thirds of the profit participation bonuses payable under this plan in the form of equity-based awards. Effective January 1, 2015, we amended the Office Profit Participation Plans and Firm Profit Participation Plan, which now provide for an overall increase in the allocation of share-based awards. The cash portion of the awards will not be subject to time-based vesting conditions and will be expensed during the performance year. The share-based portion of the awards is subject to a three-year time-based vesting schedule beginning on the first anniversary of the grant (which is made in the first calendar quarter of the subsequent year). As a result, the total expense for the share-based portion of the awards is recorded over the period from the beginning of the performance year through the vesting date, or 50 months. Therefore, under the new design, the expense recognized during the performance year will be less than the expense that would have been recognized under the previous design. We expect that difference will be recognized as an increase in expense over the subsequent three years, irrespective of our financial performance in the future periods.

Our Services

Debt Placement Services

We offer our clients access to a complete range of debt instruments, including construction and construction/mini-permanent loans, adjustable and fixed rate mortgages, entity level debt, mezzanine debt, forward delivery loans, tax exempt financing and sale/leaseback financing.

Our clients are owners of various types of property including, but not limited to, medical office related products, retail, industrial, hotel, multi-housing, student housing, self-storage, senior living, independent living, assisted living, nursing homes, condominiums and condominium conversions, mixed-use properties and land. Our clients range in size from individual entrepreneurs who own a single property to the largest real estate funds and institutional property owners throughout the world who invest globally, especially in the United States. Debt is or has been placed with major capital funding sources, both domestic and foreign, including life insurance

 

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companies, CMBS conduits, investment banks, commercial banks, thrifts, agency lenders, pension funds, pension fund advisors, real estate investment trusts (REITs), credit companies, opportunity funds and individual investors.

Investment Advisory Services

We provide investment advisory services to commercial real estate owners who are seeking to sell one or more properties or property interests. We seek to maximize proceeds and certainty of closure for our clients through our knowledge of the commercial real estate and capital markets, our extensive database of potential buyers, many of whom we have deep and long-standing relationships, and our experienced capital markets advisors. We believe the real-time data on comparable transactions, recent financings of similar assets and market trends enable our capital markets advisors to better advise our clients on valuation and certainty of execution based on a prospective buyer’s proposed capital structure and track record for closing transactions.

Equity Placement and Private Equity Services

We offer a wide array of equity placement and private equity alternatives and solutions at both the property and ownership entity level. We believe this allows us to provide financing alternatives at every level of the capital structure, including mezzanine and preferred equity, thereby providing potential buyers and existing owners with the highest appropriate leverage at the lowest blended cost of capital to purchase properties or recapitalize existing properties versus an out-right sale alternative. By focusing on the inefficiencies in the equity placement capital markets, such as mezzanine, preferred equity, participating and/or convertible debt structures, pay and accrual debt structures, pre-sales, stand-by commitments and partial interest sales bridge loans, we believe we are able to access capital for stabilized properties or properties in transition, with options including predevelopment, joint ventures, structured debt, and equity transactions, which provide maximum flexibility for our clients.

Private Equity, Investment Banking and Advisory Services

Through the Securities Subsidiaries, we offer our clients the ability to access the private equity markets for a variety of capital raises and transactions, including joint ventures, discretionary private equity funds, entity-level private placements and other structured finance transactions. Additionally, we offer our clients a range of financial advisory services. The Securities Subsidiaries’ services to their clients may include:

 

   

Joint Ventures.    Equity capital to establish joint ventures relating to either identified properties or properties to be acquired by a sponsor. These joint ventures typically can be asset-specific or programmatic and involve the acquisition, development, recapitalization or restructuring of commercial real estate assets and include a variety of property types and geographic areas.

 

   

Discretionary Funds.    Institutional marketing and fund-raising for public and private commercial real estate fund sponsors. In this capacity, we represent funds with strategies that range from core to opportunistic across a variety of property types and geographies.

 

   

Advisory Services.    Mergers and acquisitions and other corporate advisory services for various types of transactions including mergers and acquisitions, sales and divestitures, management buyouts, and recapitalizations and restructurings.

 

   

Private Placements.    Private placements of common, perpetual preferred and convertible preferred securities. Issuances can involve primary or secondary shares that may be publicly registered, listed and traded.

Loan Sales

We assist our clients in their efforts to sell all or portions of their commercial real estate debt note portfolios, which can include performing, non-performing and distressed debt as well as real estate owned properties.

 

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Commercial Loan Servicing

We provide commercial loan servicing (primary and sub-servicing) for life insurance companies, the Federal Home Loan Mortgage Corporation (“Freddie Mac”), the Federal National Mortgage Association (“Fannie Mae”) through strategic relationships with several delegated underwriting and servicing (DUS®) lenders, CMBS originators, mortgage REITS and debt funds, groups that purchase performing and non-performing loans as well as owners who sell commercial real estate subject to a purchase money mortgage. We are not a master servicer and therefore we have no advancing obligations for principal and interest nor do we have any loss sharing obligations relative to our loan servicing portfolio. Additionally, we are a rated CMBS primary and special servicer by Fitch Ratings. The primary servicer rating reflects our experienced and tenured management and staff and our long history as a commercial mortgage primary servicer, including with respect to Freddie Mac and CMBS servicing. The special servicer rating is based on our ability to work out, manage and resolve commercial mortgage loans and real estate owned assets. We believe our servicing platform, experienced personnel and hands-on service allow us to maintain close contact with both borrowers and lenders, and as a result, we are often the first point of contact in connection with refinancing, restructuring or sale of commercial real estate assets. Revenue is earned primarily from servicing fees charged to the lender.

To avoid potential conflicts, our capital markets advisors do not directly share in servicing revenue, eliminating conflicts which can occur with serviced versus non-serviced lenders, but they can be compensated, in part for this as well as other activities, through the Office Profit Participation Plans, if available and applicable, at the discretion of the office heads in our respective offices. However, throughout the servicing life of a loan, the capital market advisor who originated the loan usually remains the main contact for both the borrower and lender, or the master and/or special servicer, as the case may be, to assist our servicing group with annual inspections, operating statement reviews and other major servicing issues affecting a property or properties and in some circumstances, may be compensated for services rendered.

Competition

The commercial real estate services industry, and all of the services that we provide, are highly competitive, and we expect them to remain so. We compete on an international, national, regional, and local basis on a number of critical factors including, but not limited to, the quality of our people and client service, historical track record and expertise and range of services and execution skills, absence of conflicts and business reputation. Depending on the product or service, we face competition from other international and domestic commercial real estate service providers, institutional lenders, banks and savings and loans, CMBS conduits, insurance companies, investment banking firms and investment managers, some of which may have greater financial resources than we do. Top competitors we face on international, national, regional and local levels include, but are not limited to, CBRE Capital Markets, Cushman & Wakefield, Eastdil Secured (owned by Wells Fargo), Jones Lang LaSalle, Colliers, Cassidy Turley, Walker Dunlop, Marcus & Millichap, Newmark Group, Inc., Northmarq Capital (Marquette), Meridian and Berkadia, among others. There are numerous other local and regional competitors in each of the local markets where we are located as well as the markets in which we do business.

Competition to attract and retain qualified employees is also intense in each of the capital markets services we provide our clients. We compete by offering what we believe to be competitive compensation packages to our capital markets advisors and our other associates as well as equity-based incentives including, but not limited to, our Office and Firm Profit Participation Plans for key associates who lead our efforts in terms of running our offices or lead our efforts in each of our capital markets services and product specialties as well as through periodic omnibus awards to individuals. Our ability to continue to compete effectively will depend upon our ability to retain, motivate and compensate appropriately our existing capital markets advisors and other key associates as well as our ability to attract new talent, all predicated on finding the most experienced professionals in the market who have the highest integrity, work ethic and reputation, while fitting into our culture and sharing our philosophy and business practices.

 

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Regulation

Our Securities Subsidiaries, are subject to regulation. HFF Securities is currently registered as a broker-dealer with the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) and HFF Securities Limited, whose operations began in January 2017, is subject to regulation by the Financial Conduct Authority (FCA) in the UK. The FCA is responsible for monitoring compliance with the Financial Services and Markets Act 2000 and administering related rules. Violation of applicable FINRA and FCA regulations can result in the revocation of broker-dealer licenses, the imposition of censures or fines and the suspension, expulsion or other disciplining of a firm, its officers or employees. HFF Securities is registered as a broker-dealer in 21 states. HFF Securities is subject to regulations governing effectively every aspect of the securities business, including the effecting of securities transactions, minimum capital requirements, record-keeping and reporting procedures, relationships with customers, experience and training requirements for certain employees and business procedures with firms that are not subject to regulatory controls.

Our United States broker-dealer subsidiary is also subject to the SEC’s uniform net capital rule, Rule 15c3-1, which may limit our ability to make withdrawals of capital from our broker-dealer subsidiary. The uniform net capital rule sets the minimum level of net capital a broker-dealer must maintain and also requires that a portion of its assets be relatively liquid. FINRA may prohibit a member firm from expanding its business or paying cash dividends if resulting net capital falls below its requirements. In addition, our broker-dealer subsidiary is subject to certain notification requirements related to withdrawals of excess net capital. The USA Patriot Act of 2001 also imposes obligations regarding the prevention and detection of money-laundering activities, including the establishment of customer due diligence and other compliance policies and procedures, and procedures for customer verification. Failure to comply with these requirements may result in monetary, regulatory and, in the case of the USA Patriot Act, criminal penalties.

HFF LP is licensed (in some cases, through our employees or its general partner) as a mortgage broker and a real estate broker in multiple jurisdictions. Generally, we are licensed in each state where we have an office as well as where we frequently do business.

Seasonality

Historically, during normal economic and capital markets conditions, our capital markets services revenue is typically seasonal. This seasonality has caused our revenue, operating income, net income and cash flows from operating activities to be lower in the first six months of the year and higher in the second half of the year. We believe the concentration of earnings and cash flows in the last six months of the year has historically been due to an industry-wide focus of clients to complete transactions towards the end of the calendar year. However, this historical pattern of seasonality may or may not continue.

Employees

Our total employment was 982 employees as of December 31, 2017, which represents a 10.2% increase from the December 31, 2016 total employment of 891 employees.

Liquidity and Capital Resources

Information concerning the Company’s liquidity and capital resources can be found in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.

History

We have grown through the combination of several prominent commercial real estate brokerage firms. Our namesake dates back to Holliday Fenoglio & Company, which was founded in Houston in 1982. Although our

 

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predecessor companies date back to the 1970s, our recent history began in 1994 when Holliday Fenoglio Dockerty & Gibson, Inc. was purchased by AMRESCO, Inc. to create Holliday Fenoglio Inc. In 1998, Holliday Fenoglio, Inc. acquired Fowler Goedecke Ellis & O’Connor to create Holliday Fenoglio Fowler, L.P. Later that year, Holliday Fenoglio Fowler, L.P. acquired PNS Realty Partners, LP and Vanguard Mortgage.

In March 2000, AMRESCO sold select assets including portions of its commercial mortgage banking businesses, Holliday Fenoglio Fowler, L.P., to Lend Lease (US) Inc., the U.S. subsidiary of the Australian real estate services company. In June 2003, HFF Holdings completed an agreement for a management buyout from Lend Lease. In April 2004, we established HFF Securities L.P., a broker-dealer subsidiary.

As previously discussed in “Special Note Regarding the Registrant,” in connection with our initial public offering of our Class A common stock in February 2007, we effected a reorganization of our business. In connection with the Reorganization Transactions, HFF, Inc. was incorporated in Delaware in November 2006 and became, and continues to be, a holding company holding partnership units in the Operating Partnerships and all of the outstanding shares of Holliday GP. Following the Reorganization Transaction and prior to August, 31, 2012, HFF Holdings and HFF, Inc., through their wholly-owned subsidiaries, were the only limited partners of the Operating Partnerships. During the period between November 30, 2009 and August 31, 2012, HFF Holdings exchanged all of the remaining partnership units that it held in each of the Operating Partnerships for shares of Class A common stock of the Company. Following such exchanges and continuing through the filing date of this Annual Report on Form 10-K, HFF, Inc., through its wholly-owned subsidiaries, holds 100% of the partnership units in the Operating Partnerships.

Available Information

Our internet website address is www.hfflp.com. The information on our internet website is not incorporated by reference in this Annual Report on Form 10-K. Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, ownership reports for insiders and any amendments to these reports filed or furnished with the SEC pursuant to Section 13(a) and 15(a) of the Securities Exchange Act of 1934, as amended, are available free of charge through our internet website as soon as reasonably practicable after filing with the SEC. Additionally, we make available free of charge on our internet website:

 

   

our Code of Conduct and Ethics;

 

   

the charter of the Nominating and Corporate Governing Committee of our Board of Directors;

 

   

the charter of the Compensation Committee of our Board of Directors;

 

   

the charter of the Audit Committee of our Board of Directors; and

 

   

our Corporate Governance Guidelines.

 

Item 1A.    Risk Factors

Investing in our securities involves a high degree of risk. You should consider carefully the following risk factors and the other information in this Annual Report on Form 10-K, including our consolidated financial statements and related notes, before making any investment decisions regarding our securities. If any of the following risks actually occur, our business, financial condition and operating results could be adversely affected. As a result, the trading price of our securities could decline and you may lose part or all of your investment.

Risks Related to Our Business

General economic conditions and commercial real estate market conditions, both globally and domestically, have had and may in the future have a negative impact on our business.

The commercial real estate market is inherently cyclical. We have previously experienced and expect in the future to be negatively impacted by, periods of economic slowdowns, recessions and disruptions in the capital

 

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markets; credit and liquidity issues in the global and domestic capital markets, including international, national, regional and local markets; and corresponding declines in the demand for commercial real estate and related services within one or more of the markets in which we operate. Historically, commercial real estate markets, and in particular the U.S. commercial real estate market, have tended to be cyclical and related to the flow of capital to the sector, the condition of the economy as a whole and to the perceptions and confidence of the market participants as to the relevant economic outlook as well as the asset class. Negative economic conditions, changes in interest rates, credit and liquidity issues in the global and domestic capital markets, disruptions in capital markets and declines in the demand for commercial real estate and related services in international or domestic markets or in significant markets in which we do business as well as negative perceptions about the asset class, have had and could have in the future a material adverse effect on our business, results of operations and financial condition. Since the latter half of 2009, there has been an improvement in the U.S. financial markets, increasing confidence and stabilization in domestic and some foreign economies as well as in select U.S. cities which has provided increasing demand for high quality core, core plus and value-add commercial real estate assets. However, we can give no assurance that the improvements in the U.S. commercial real estate market are sustainable.

The following factors are examples of economic conditions that could negatively impact our business:

 

   

Slowdowns in economic activity or other disruptions in capital markets could cause tenant demand for space to decline, which would adversely affect the operation and income of commercial real estate properties and thereby affect investor demand and the supply of capital for debt and equity investments in commercial real estate.

 

   

Declines in the regional or local demand for commercial real estate, or significant disruptions in other segments of the real estate markets or capital markets, could adversely affect our results of operations. During 2017, approximately 17.8%, 13.9%, 6.1%, 5.7% and 4.4% of the Company’s capital markets services revenues were derived from transactions involving commercial real estate located in Texas, California, Florida, New York and the region consisting of the District of Columbia, Maryland and Virginia, respectively. As a result, a significant portion of our business is dependent on the economic conditions in general and in certain markets for commercial real estate such as in these areas, which, like other commercial real estate markets, have experienced price volatility or economic downturns in the past.

 

   

Global and domestic credit and liquidity issues, significant fluctuations in interest rates as well as steady and protracted increases or decreases of interest rates could adversely affect the operation and income of commercial real estate properties as well as the demand from investors for commercial real estate investments. Any of these events could adversely affect investor demand and the supply of capital for debt and equity investments in commercial real estate. In particular, the lack of debt or equity for commercial real estate transactions, the resulting re-pricing of debt and equity risk or increased/decreased interest rates may reduce the number of acquisitions, dispositions and loan originations, as well as the Company’s or firm’s respective transaction volumes. These factors and events could also cause prices to decrease due to the reduced amount of financing available as well as the increased cost of obtaining financing, and could lead to a decrease in purchase and sale activity and therefore a decrease in revenue to the Company.

 

   

Significant disruptions or changes in capital market flows, as well as credit and liquidity issues in the global and domestic capital markets, regardless of their duration, could adversely affect the supply of and demand for capital from investors for commercial real estate investments. Changes in the perception that commercial real estate is an accepted asset class for portfolio diversification could also result in a significant reduction in the amount of debt and equity capital available in the commercial real estate sector.

 

   

Following a referendum on June 23, 2016, in which a majority of voters in the UK approved an exit from the European Union, it is expected that the UK government will initiate a process to leave the European

 

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Union (“Brexit”). Brexit could adversely impact UK, European and global economic or market conditions and could contribute to instability in the global financial markets. Additionally, Brexit could lead to legal uncertainty and potentially divergent national laws and regulations as the UK determines which European Union laws to replace or replicate. We may incur additional costs and expenses as we adapt to a changing regulatory framework in the UK and the effects of Brexit could adversely affect our business, business opportunities, results of operations and financial condition.

These and other types of events could lead to a further decline in transaction activity as well as a decrease in values, which would likely in turn lead to a reduction in fees and commissions relating to such transactions. These effects would likely cause us to realize lower revenues from our transaction service fees, including debt placement fees, investment advisory commissions, and our private equity and advisory fees, which fees usually are tied to the transaction value and are payable upon the successful completion of a particular transaction. Such declines in transaction activity and value would likely also significantly reduce our loan servicing activities and revenues as a result of increased delinquencies and defaults on the loans we service and the lack of additional loans that we would have otherwise added to our servicing portfolio.

In addition, cyclicality in the commercial real estate markets may result in cyclicality in our results of operation as well as significant volatility in the market price of our Class A common stock. Similar to other providers of commercial real estate and capital markets services, the stock price of our Class A common stock has had significant declines and fluctuations in the past and may experience similar declines in the future.

Although we operate globally, we report our results in U.S. dollars, and thus our reported results may be positively or negatively impacted by the strengthening or weakening of currencies against the U.S. dollar. As an example, the pound sterling, a currency used in our operations, has fluctuated significantly in recent years. In addition to the potential negative impact on reported earnings, fluctuations in currencies relative to the U.S. dollar may make it more difficult to perform period-to-period comparisons of the reported results of operations.

We do not use hedging instruments for speculative purposes; however, we are authorized to use currency-hedging instruments, including foreign currency forward contracts, purchased currency options and borrowings in foreign currency in an effort to reduce interest rate and foreign currency risk. There can be no assurance that such hedging will be economically effective.

Our business has been and may in the future be adversely affected by restrictions in the availability of debt or equity capital as well as a lack of adequate credit and the risk of deterioration of the debt or credit markets and commercial real estate markets.

Restrictions on the availability of capital, both debt and/or equity, can create significant reductions in the liquidity and flow of capital to the commercial real estate markets. Severe restrictions in debt or equity liquidity as well as the lack of the availability of credit in the markets we serviced between 2008 and early 2010 significantly reduced the volume and pace of commercial real estate transactions compared with past periods. These restrictions also had a general negative effect upon commercial real estate prices themselves. Our business of providing commercial real estate and capital markets services to our clients, who are both consumers and providers of capital, is particularly sensitive to the volume of activity and pricing in the commercial real estate market. In particular, global and domestic credit and liquidity issues reduced the number of acquisitions, dispositions and loan originations between 2008 and early 2010, compared to prior periods, which may also occur into the future. This has had, and may have in the future, a significant adverse effect on our capital markets services revenues.

Despite the general improvement in the U.S. stock markets that started in the second half of 2009, global and domestic credit restrictions and market uncertainties continue, and we cannot predict with any degree of certainty the magnitude or duration of the recent developments in the credit markets and commercial real estate markets as it is inherently difficult to make accurate predictions with respect to such macroeconomic movements

 

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that are beyond our control. This uncertainty limits our ability to plan for future developments. In addition, the uncertainty regarding current market conditions may limit the ability of other participants in the credit markets or commercial real estate markets to plan for the future. As a result, market participants may act more conservatively than they might in a stabilized market, which may perpetuate and amplify the adverse developments in the markets we service. While business opportunities may emerge from assisting clients with transactions relating to distressed commercial real estate assets, there can be no assurance that the volume of such transactions will be sufficient to meaningfully offset the declines in transaction volumes within the overall commercial real estate market.

If we are unable to retain and attract qualified and experienced capital markets advisors and associates, our growth may be limited and our business and operating results could suffer.

Our most important asset is our people, and our continued success is highly dependent upon the efforts of our capital markets advisors and other associates, including our analysts and production coordinators as well as our key servicing and company overhead support associates. Our capital markets advisors generate a significant majority of our revenues. If any of these key capital markets advisors or other important associates leave, or if we lose a significant number of capital markets advisors, or if we are unable to attract other qualified capital markets advisors, our business, financial condition and results of operations may suffer. We have experienced in the past, and expect to experience in the future, the negative impact of the inability to retain and attract associates, analysts and experienced capital markets advisors. Additionally, such events may have a disproportionate adverse effect on our operations if the senior most experienced capital markets advisors do not remain with us or if these events occur in geographic areas where substantial amounts of our capital markets services revenues are generated. Moreover, because a significant portion of the compensation paid to our capital markets advisors consists of commissions, in general our capital markets advisors receive significantly less compensation at times when we have substantial declines in our capital markets services revenues, and may therefore have less incentive to remain with the Company during such challenging periods.

We use a combination of cash compensation, equity, equity-based incentives and other employee benefits rather than solely cash compensation to motivate and retain our capital markets advisors. Our compensation mechanisms may not be effective, however, if the market price of our Class A common stock experiences significant declines such as what occurred during 2008 and 2009. Even if we are able to retain our most valuable capital markets advisors, we may not be able to retain them at compensation levels that will allow us to achieve our target ratio of compensation expense to operating revenue.

In addition, our competitors may attempt to recruit our capital markets advisors. The employment arrangements we have entered into or may enter into with our key associates may not prevent our capital markets advisors and other key associates from resigning or competing against us. While certain key associates may be subject to various non-competition agreements or non-solicitation arrangements, except in a few isolated situations, we do not have employment covenants, including non-competition or non-solicitation arrangements, with certain other key associates and there is no assurance that we will be able to retain their services. If their employment were to be terminated, they would be free to compete against the Company or solicit its employees for business or its customers for commercial opportunities.

A significant component of our growth has also occurred through the recruiting, hiring and retention of key experienced capital markets advisors as well as through the recruiting, hiring and retention of associates who have subsequently become capital markets advisors. Any future growth through recruiting these types of capital markets advisors and associates will be partially dependent upon the continued availability of attractive candidates fitting the culture of our firm at advantageous employment terms and conditions. However, individuals whom we would like to hire may not be available upon advantageous employment terms and conditions. In addition, the hiring of new personnel involves risks that the persons acquired will not perform in accordance with expectations and that business judgments concerning the value, strengths and weaknesses of persons acquired will prove incorrect.

 

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Negative developments in the business of certain of our clients or counterparties could adversely affect our results of operation and financial condition.

Our clients are both consumers of capital, such as property owners, and providers of capital, such as lenders and equity investors. Defaults or non-performance by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity crises and could lead to losses or defaults by one or more of our clients, which, in turn, could have a material adverse effect on our results of operations and financial condition. In addition, a client may fail to make payments when due, become insolvent or declare bankruptcy. Any client bankruptcy or insolvency or the failure of any client to make payments when due could result in material losses to our company. In particular, if any of our significant clients becomes insolvent or suffers a downturn in its business, it may seriously harm our business. While in 2017 and 2016 no one borrower or no one seller client represented more than 4% of our total capital markets services revenues, bankruptcy filings by or relating to one of our clients could delay or bar us from collecting pre-bankruptcy debts from that client.

The bankruptcy or insolvency of a significant counterparty (which may include co-brokers, lenders including, but not limited to, Freddie Mac and Fannie Mae which are in conservatorship, insurance companies, banks, hedging counterparties, service providers or other organizations with which we do business), or the failure of any significant counterparty to perform its contractual commitments, may also result in a disruption to our business or material losses to our company.

We have numerous significant competitors and potential future competitors, some of which may have greater resources than we do, and we may not be able to continue to compete effectively.

We compete across a variety of businesses within the commercial real estate industry. In general, with respect to each of our businesses, we cannot give assurance that we will be able to continue to compete effectively or maintain our current fee arrangements or margin levels, or that we will not encounter increased competition. Each of the services we provide to our clients is highly competitive on an international, national, regional and local level. Depending on the product or service, we face competition from international and domestic groups, commercial real estate service providers, private owners and developers, institutional lenders, insurance companies, banks, CMBS originators, debt funds, hedge funds, investment banking firms and investment managers, some of whom are clients and many of whom may have greater financial resources than we do. In addition, future changes in laws and regulations could lead to the entry of other competitors. Many of our competitors are local, regional, national or international firms. Although some are substantially smaller than we are, some of these competitors are significantly larger on a local, regional, national or international basis. We may face increased competition from even stronger competitors in the future due to a trend toward consolidation, especially in times of severe economic stress such as what we experienced in 2008 through 2010. In recent years, there has been substantial consolidation and convergence among companies in our industry. Our existing and future competitors may choose to undercut our fees, increase the levels of compensation they are willing to pay to their employees and either recruit our employees or cause us to increase our level of compensation necessary to retain our own employees or recruit new employees. These occurrences could cause our revenue to decrease or negatively impact our target ratio of compensation to operating revenue, both of which could have an adverse effect on our business, financial condition and results of operations.

Our business could be hurt if we are unable to retain our business philosophy and partnership culture and efforts to retain our philosophy and culture could adversely affect our ability to maintain and grow our business.

We are deeply committed to maintaining the philosophy and culture which we have built. Our Mission and Vision Statement defines our business philosophy as well as the emphasis that we place on our clients, our people and our culture. We seek to reinforce to each of our associates our commitment to our clients, our culture and values by sharing with everyone in the firm what is expected from each of them. We strive to maintain a work

 

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environment that reinforces our owner-operator culture and the collaboration, motivation, alignment of interests and sense of ownership and reward associates based on their value-added performance who adhere to this culture. Our status as a public company, including potential changes in our compensation structure, could adversely affect this culture. If we do not continue to develop and implement the right processes, tools and appropriate compensation, including equity compensation, for our associates in order to manage our changing enterprise and maintain this culture, our ability to compete successfully and achieve our business objectives could be impaired, which could negatively impact our business, financial condition and results of operations.

In addition, in an effort to preserve our strong partnership culture, our process for hiring new capital markets advisors is lengthy and highly selective. In the past, we have interviewed a significant number of individuals for each capital market advisor that we hired, and we have and may in the future subordinate our growth plans to our objective of hiring capital markets advisors whom we think will adhere to and contribute to our culture. Our ability to maintain and grow our business could suffer if we are not able to identify, hire and retain new capital markets advisors meeting our high standards, which could negatively impact our business, financial condition and results of operations.

In the event that we experience significant growth in the future, such growth may be difficult to sustain and may place significant demands on our administrative, operational and financial resources.

In the event that we experience significant growth in the future, such growth could place additional demands on our resources and increase our expenses. Our future growth will depend, among other things, on our ability to successfully identify experienced capital markets advisors to join our firm and continue to retain, grow and develop the leadership to manage our business. It may take years for us to determine whether new capital markets advisors will be profitable or effective. During that time, we may incur significant expenses and expend significant time and resources toward training, integration and business development. If we are unable to hire and retain profitable capital markets advisors as well as our leadership, we will not be able to implement our growth strategy, which could adversely affect our business, financial condition and results of operations.

Growth will also require us to commit additional management, operational and financial resources to maintain appropriate operational and financial systems to adequately support expansion. There can be no assurance that we will be able to manage our expanding operations effectively or that we will be able to maintain or accelerate our growth. Any failure to manage our growth could adversely affect our ability to generate revenue and control our expenses, which could adversely affect our business, financial condition and results of operations.

Moreover, we may have to delay, alter or eliminate the implementation of certain aspects of our growth strategy due to events beyond our control, including, but not limited to, changes in general economic conditions, flows in the capital markets and negative changes in commercial real estate market conditions as well as negative perceptions about the commercial real estate asset class. Such delays or changes to our growth strategy may adversely affect our business.

If we acquire companies or significant groups of personnel in the future, we may experience high transaction and integration costs, the integration process may be disruptive to our business and the acquired businesses or personnel may not perform as we expect.

Future acquisitions of companies or capital markets advisors and any necessary related financings may involve significant transaction-related expenses such as severance costs, lease termination costs, transaction costs, deferred financing costs, possible regulatory costs and merger-related costs, among others. We may also experience difficulties in integrating operations and accounting systems acquired from other companies. These challenges include, but are not limited to, the diversion of management’s attention from the regular operations of our business and the potential loss of our key clients, our key associates or those of the acquired operations, each of which could harm our financial condition and results of operation. We believe that most acquisitions will

 

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initially have an adverse impact on revenues, expenses, operating income and net income. Acquisitions also frequently involve significant costs related to integrating culture, people, information technology, accounting, reporting and management services and rationalizing personnel levels. If we are unable to fully integrate the culture, accounting, reporting and other systems of the businesses we acquire, we may not be able to effectively manage them and our financial results may be materially affected. Moreover, the integration process itself may be disruptive to our business as it requires coordination of culture, people and geographically diverse organizations and implementation of new accounting and information technology systems.

In addition, acquisitions of businesses involve risks that the businesses acquired will not perform in accordance with expectations, that the expected synergies associated with acquisitions will not be achieved and that business judgments concerning the value, strengths and weaknesses of the people and the businesses acquired will prove incorrect, which could have an adverse effect on our business, financial condition and results of operations.

Additional indebtedness or an inability to obtain indebtedness may make us more vulnerable to economic downturns and limit our ability to withstand competitive pressures.

We may be required to obtain additional financing to fund our on-going capital needs as well as to fund our working capital needs. Any additional indebtedness that we may incur will make us more vulnerable to economic downturns and limit our ability to withstand competitive pressures. In addition, an inability to obtain additional indebtedness will also make us more vulnerable to economic downturns and limit our ability to withstand competitive pressures.

The level of our indebtedness or inability to obtain additional indebtedness could have important consequences, such as:

 

   

a substantial portion of our cash flow from operations may be dedicated to debt service and may not be available for other purposes;

 

   

our cash flow from operations may be insufficient to fund our business operations and our inability to obtain financing will make it more difficult to fund our operations;

 

   

making it more difficult for us to satisfy our obligations;

 

   

limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;

 

   

obtaining financing in the future for our warehouse lending activities related to the Freddie Mac Multifamily Approved Seller/Servicer for Conventional and Senior Housing Loans program, (the “Freddie Mac Program”), working capital, capital expenditures and general corporate purposes, including acquisitions, and may impede our ability to process our capital markets platform services as well as to secure favorable lease terms;

 

   

making it more difficult to continue to fund our current operations as well as our strategic growth initiatives and retain and attract key individuals; and

 

   

placing us at a competitive disadvantage compared to our competitors with less debt and greater financial resources.

Our future cash flow may not be sufficient to meet our obligations and commitments. In addition, with the exception of our uncommitted warehouse lines of credit used exclusively in connection with our participation in the Freddie Mac Program we do not currently maintain a revolving or other credit facility. While we currently believe that cash flows from operating activities and our existing cash balances will be sufficient to meet our working capital needs for the foreseeable future, we cannot make any assurances that we will not be required to incur indebtedness in the future. If we are unable to obtain additional financing or generate sufficient cash flow from operations in the future to service our indebtedness and to meet our other commitments, we will be required

 

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to adopt one or more alternatives including, but not limited to, closing offices, selling material assets or operations, seeking to raise additional debt or equity capital, eliminating certain lines of our capital markets platforms or terminating significant numbers of key associates. These actions may not be effected on a timely basis or on satisfactory terms or at all, and these actions may not enable us to continue to satisfy our operating or capital requirements. As a result, we may not be able to maintain or accelerate our growth, and any failure to do so could adversely affect our ability to generate revenue and control our expenses, which could adversely affect our business, financial condition and results of operations.

The financial institutions with whom we currently do business may be unable or unwilling to provide funding under our current financing arrangements.

A diminution in the ease at which our current financing sources can be drawn upon could negatively impact our liquidity. We are party to an uncommitted $600 million financing arrangement with PNC Bank, N.A. (“PNC”). The PNC arrangement was modified during the third quarter of 2017 to increase the uncommitted amount from $450 million to $600 million which can be increased to $800 million an unlimited number of times per year for a period of 30 calendar days. The maximum capacity was also increased to $1.5 billion. On October 2, 2017, HFF LP entered into an extended funding agreement with Freddie Mac whereby Freddie Mac could extend the required purchase date for each mortgage that has an Original Funding Date (as defined in the agreement) occurring within the fourth quarter of 2017, to February 15, 2018. In connection with the extended funding agreement with Freddie Mac, PNC agreed to increase its financing arrangement to $2.0 billion. The maximum capacity under the PNC arrangement will revert to $1.5 billion after the expiration of the extended funding agreement. The Company is also party to an uncommitted $150 million financing arrangement with The Huntington National Bank (“Huntington”). The Huntington arrangement was amended in July 2017 to increase the uncommitted amount from $125 million to $150 million, which can be increased to $175 million three times in a one-year period for 45 calendar days and may be increased to $175 million from October 1, 2017 through February 15, 2018.

Each funding is separately approved on a transaction-by-transaction basis and is collateralized by a loan and mortgage on a multifamily property that is ultimately purchased by Freddie Mac. The PNC and Huntington financing arrangements are only for the purpose of supporting the Company’s participation in the Freddie Mac Program and cannot be used for any other purpose. As of December 31, 2017 and December 31, 2016, HFF LP had $450.3 million and $291.0 million, respectively, outstanding on the warehouse lines of credit. Interest on the warehouse lines of credit is at the 30-day LIBOR rate 1.37% and 0.62% at December 31, 2017 and December 31, 2016, respectively) plus a spread. HFF LP is also paid interest on the mortgage note receivable secured by a multifamily loan at the rate in the Freddie Mac note. Although we believe that our current financing arrangements with PNC and Huntington are sufficient to meet our current needs in connection with our participation in the Freddie Mac Program, in the event we are not able to secure financing for our Freddie Mac loan closings, we will cease originating such Freddie Mac loans until we have available financing which could have an adverse effect on our business, financial condition and results of operations.

A failure to appropriately deal with actual or perceived conflicts of interest could adversely affect our businesses.

Outside of our people, our reputation is one of our most important assets. As we have expanded the scope of our businesses, capital markets platforms and our client base, we increasingly have to address potential, actual or perceived conflicts of interest relating to the capital markets services we provide to our existing and potential clients. For example, conflicts may arise between our position as an advisor to both the buyer and seller in commercial real estate sales transactions or in instances when a potential buyer requests that we represent it in securing the necessary capital to acquire an asset we are selling for another client or when a capital source takes an adverse action against an owner client that we are representing in another matter. In addition, certain of our employees hold interests in real property as well as invest in pools of funds outside of their capacity as our employees, and their individual interests could be perceived to or actually conflict with the interests of our

 

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clients. While we believe we have attempted to adopt various policies, controls and procedures to address or limit actual or perceived conflicts, these policies and procedures may not be adequate or carry attendant costs and may not be adhered to by our employees. Appropriately dealing with conflicts of interest is complex and difficult and our reputation could be damaged causing us to lose existing clients or fail to gain new clients if we fail, or appear to fail, to deal appropriately with conflicts of interest, which could have an adverse effect on our business, financial condition and results of operations.

A majority of our revenue is derived from short-term capital markets services transaction fees, subject to external economic conditions and intense competition, and declines in those engagements could have a material adverse effect on our financial condition and results of operations.

We historically have earned over 90% of our revenue from capital markets services transaction fees. We expect that we will continue to rely heavily on capital markets services transaction fees for a substantial portion of our revenue for the foreseeable future. A decline in our engagements or in the value of the commercial real estate we sell or finance could significantly decrease our capital markets services revenues which would adversely affect our business, financial condition and results of operations. In addition, we operate in a highly competitive environment which is heavily reliant on a healthy economy and a functioning and fluid global capital market, where typically there are no long-term contracted sources of revenue. Generally, each of our revenue-generating engagements are separately awarded and negotiated on a transaction-by-transaction basis. The inability to continue to be paid for services at the current levels or the loss of clients would adversely affect our business, financial condition and results of operation.

Significant fluctuations in our revenues and net income may make it difficult for us to achieve steady earnings growth on a quarterly or an annual basis, which may make the comparison between periods difficult and may cause the price of our Class A common stock to decline.

We have experienced and continue to experience significant fluctuations in revenues and net income as a result of many factors including, but not limited to, economic conditions, capital markets disruptions, the timing of transactions, the commencement and termination of contracts, revenue mix and the timing of additional selling, general and administrative expenses to support new business activities. We provide many of our services without written contracts or pursuant to contracts that are terminable at will. Consequently, many of our clients can terminate or significantly reduce their relationships with us on very short notice for any reason.

We plan our capital and operating expenditures based on our expectations of future revenues and, if revenues are below expectations in any given quarter or year, we may be unable to adjust capital or operating expenditures in a timely manner to compensate for any unexpected revenue shortfall, which could have an immediate material adverse effect on our business, financial condition and results of operation.

Our results of operation vary significantly among quarters during each calendar year, which makes comparisons of our quarterly results difficult.

A significant portion of our revenue is typically seasonal. Historically, during normal economic and capital markets conditions, this seasonality has caused our revenue, operating income, net income and cash flows from operating activities to be lower in the first six months of the year and higher in the second half of the year. This variance among periods during each calendar year makes comparison between such periods difficult, and it also makes the comparison of the same periods during different calendar years difficult as well. However, this seasonality did not occur in 2007 or 2008 during the disruptions facing all global capital markets, and in particular the U.S. commercial real estate markets, and this historical pattern of seasonality may or may not continue.

Our existing goodwill and other intangible assets could become impaired, which may require us to take non-cash charges.

Under current accounting guidelines, we evaluate our goodwill and intangible assets for potential impairment annually or more frequently if circumstances indicate impairment may have occurred.

 

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As of December 31, 2017, our recorded goodwill was approximately $8.7 million and our intangible assets, net, were $58.8 million. The Company performs the required annual goodwill impairment evaluation in the fourth quarter of each year, or more frequently if there are indicators of impairment. No impairment of goodwill was determined to exist for the years ended December 31, 2017, 2016 or 2015. Our intangible assets primarily include mortgage servicing rights under agreements with third party lenders. As of December 31, 2017, the fair value and net book value of the Freddie Mac, CMBS and Life Company servicing rights were $75.9 million and $58.5 million, respectively. The most sensitive assumptions in estimating the fair value of the mortgage servicing rights are the level of prepayments, discount rate and cost of servicing. If the assumed level of prepayments increased 107%, the discount rate increased 70% or if there is a 12% increase in the cost of servicing at the stratum level, the estimated fair value of the servicing rights may result in the recorded mortgage servicing rights being potentially impaired and would require management to measure the amount of the impairment charge. The effect of a variation in each of these assumptions on the estimated fair value of the servicing rights is calculated independently without changing any other assumption. For further detail, refer to “Critical Accounting Policies” within Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Annual Report on Form 10-K. Any impairment of goodwill or other intangible assets would result in a non-cash charge against earnings, which charge could materially adversely affect our reported results of operations and the market price of our Class A common stock in future periods.

Our existing deferred tax assets may not be realizable, which may require us to take significant non-cash charges.

The Company accounts for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and for tax losses and tax credit carryforwards, if any. Deferred tax assets and liabilities are measured using tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates are recognized in income in the period of the tax rate change, such as what occurred as a result of the U.S. Tax Cuts and Jobs Act of 2017 (the “2017 Tax Act”) which was signed into law on December 22, 2017. In assessing the realizability of deferred tax assets, the Company considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized.

Our effective tax rate is sensitive to several factors including changes in the mix of our geographic profitability. We evaluate our estimated tax rate on a quarterly basis to reflect changes in: (i) our geographic mix of income, (ii) legislative actions on statutory tax rates and (iii) tax planning for jurisdictions affected by double taxation. We continually seek to develop and implement potential strategies and/or actions that would reduce our overall effective tax rate.

The net deferred tax asset of $50.9 million at December 31, 2017 is comprised mainly of a $57.8 million deferred tax asset related to the a tax basis step-up election under Section 754 of the Internal Revenue Code, as amended (“Section 754”), made by HFF, Inc. relating to the initial purchase of units of the Operating Partnerships in connection with the Reorganization Transactions and a tax basis step-up on subsequent exchanges of Operating Partnership units for shares of the Company’s Class A common stock since the date of the Reorganization Transactions. The deferred tax asset related to the Section 754 election tax basis step up of $57.8 million represents annual pre-tax deductions on the Section 754 basis step up less past payments under the tax receivable agreement of approximately $38.4 million in 2018, then increasing to $45.7 million in 2021 then decreasing over the next eight years to approximately $0.1 million by 2029. In order to realize the anticipated pre-tax benefit of approximately $38.4 million in 2018, the Company needs to generate approximately $369 million in revenue, assuming our current cost structure. In the event that the Company cannot realize the annual benefit each year, the shortfall becomes a net operating loss that can be carried forward indefinitely to offset future taxable income. If it is more likely than not that the Company would not be able to generate a sufficient level of taxable income through the carryforward period, a valuation allowance would be recorded as a charge to income tax expense and a proportional reduction in the payable under the tax receivable agreement which would be recorded as income in the consolidated statements of comprehensive income.

 

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Employee misconduct, which is difficult to detect and deter, could harm us by impairing our ability to attract and retain clients and subjecting us to significant legal liability and reputational harm.

If our associates engage in misconduct, our business could be adversely affected. For example, our business often requires that we deal with confidential matters of great significance to our clients. It is not always possible to deter employee misconduct, and the precautions we take to deter and prevent this activity may not be effective in all cases. If our associates were improperly to use or disclose confidential information provided by our clients, we could be subject to regulatory sanctions and suffer serious harm to our reputation, financial position and current client relationships and our ability to attract future clients, could be significantly impaired, which could adversely affect our business, financial condition and results of operation.

Compliance failures and changes in regulation could result in an increase in our compliance costs or subject us to sanctions or litigation.

A number of our services are subject to regulation by the SEC, FINRA and state real estate commissions and securities regulators. Beginning in January 2017, certain of our activities are also subject to regulation by the FCA. Our failure to comply with applicable laws or regulations could result in fines, suspensions of personnel or other sanctions, including revocation of the registration of us or any of our subsidiaries as a commercial real estate broker or broker-dealer. Even if a sanction imposed against us or our personnel is small in monetary amount, the adverse publicity arising from the imposition of sanctions against us by regulators could harm our reputation and cause us to lose existing clients or significantly impair our ability to gain new clients. Our broker-dealer operations are subject to periodic examination by the SEC and FINRA. FINRA may identify deficiencies in the procedures and practices of HFF Securities and may require HFF Securities to take remedial action. FINRA may also identify significant violations of law, rules or regulations, resulting in formal disciplinary action and the imposition of sanctions, including potentially the revocation of HFF Securities’ registration as a broker-dealer. We cannot predict the outcome of any such examinations or processes, and any negative regulatory action may have a significant and material adverse effect on our company. In addition, it is possible that the regulatory scrutiny of, and litigation in connection with, conflicts of interest will make our clients less willing to enter into transactions in which such a conflict may occur, and significantly impair our ability to gain new clients, which could adversely affect our business, financial condition and results of operation.

Additionally, changes in risk retention rules related to the Dodd-Frank Act and Basel III global regulations could adversely affect financial institutions and their ability, willingness and competitiveness in providing capital to the commercial real estate industry both globally and domestically. Any of these events could result in a general decline in acquisition, disposition and financing activities, which could lead to a reduction in our fees for arranging such transactions as well as a reduction in our loan servicing activities due to increased delinquencies and lack of additional loans that we would have otherwise added to our portfolio, all of which could adversely affect our business, financial condition and results of operation.

In addition, we may be adversely affected as a result of new or revised legislation or regulations adopted by the SEC, state, local or national governmental regulatory authorities or self-regulatory organizations that supervise the financial and commercial real estate markets as well as changes in administrations or enforcement priorities of any of these authorities or organizations.

Cyber incidents may adversely impact our operations.

Our business has become increasingly dependent upon digital technologies, including information systems, infrastructure and cloud applications, and the maintenance of our financial and other records is dependent upon such technologies. In general, cyber incidents can result from deliberate attacks or unintentional events. Cyber-security matters impacting our business could include gaining unauthorized access to our digital systems for purposes of misappropriating assets or sensitive information, corrupting data, or causing operational disruption. Deliberate attacks on, or unintentional events affecting, our systems or infrastructure, the systems or

 

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infrastructure of third parties or the cloud could lead to corruption or loss of our proprietary data and potentially sensitive data, reputational damage, challenges in maintaining our books and records, communication interruptions, other operational disruptions and third-party liability. Further, as cyber incidents continue to evolve, we may be required to expend additional resources to continue to modify or enhance our protective measures or to investigate and remediate any vulnerability to cyber incidents. As a result, our future operating results and ability to effectively provide our services could be materially adversely affected.

We could be adversely affected if our executive compensation programs are scrutinized or influenced by shareholder advocacy groups.

In recent years, all public companies in the United States have faced increasing shareholder scrutiny of the executive compensation practices. Through legislation such as the Dodd-Frank Act, shareholders have been given new or stronger rights to approve the pay practices, including the issuance of equity compensation, of public companies. In addition, the influence of independent shareholder advocacy groups on the decisions of institutional investors related to executive compensation matters has increased significantly. In the event that shareholder influence results in a change in our compensation mechanisms, including our ability to issue equity compensation, we may have difficulty in retaining capital markets advisors or retaining them at compensation levels that we deem appropriate. To the extent that shareholder influence prevents us from deducting executive compensation costs, we could experience additional tax costs with respect to our compensation mechanisms.

Risks Related to Our Organizational Structure

Our only material assets are our units in the Operating Partnerships and capital stock of the UK Subsidiaries, and we are accordingly dependent upon distributions from the Operating Partnerships to pay our expenses, taxes and dividends (if and when declared by our board of directors).

HFF, Inc. is a holding company and has no material assets other than its ownership of partnership units in the Operating Partnerships and capital stock of the UK Subsidiaries. HFF, Inc. has no independent means of generating revenue. We intend to cause the Operating Partnerships to make distributions to its partners in an amount sufficient to cover all expenses, applicable taxes payable and dividends, if any, declared by our board of directors. To the extent that HFF, Inc. needs funds, and the Operating Partnerships are restricted from making such distributions under applicable law or regulation or under any future debt covenants, or are otherwise unable to provide such funds, it could materially adversely affect our business, liquidity, financial condition and results of operation.

We will be required to pay HFF Holdings for most of the benefits relating to any additional tax depreciation or amortization deductions we may claim as a result of the tax basis step-up we receive and related transactions with HFF Holdings.

As part of the Reorganization Transactions, approximately 45% of the partnership units in each of the Operating Partnerships (including partnership units in the Operating Partnerships held by Holliday GP) held by Holdings Sub, a wholly-owned subsidiary of HFF Holdings, were sold to HoldCo LLC, our wholly-owned subsidiary, for cash raised in the initial public offering. In addition, HFF Holdings gained, through the issuance of one share of HFF, Inc.’s Class B common stock to HFF Holdings, the right to exchange its remaining partnership units in the Operating Partnerships held by HFF Holdings for shares of Class A common stock, subject to certain restrictions (the “Exchange Right”). As of August 31, 2012, all of the 20,355,000 partnership units previously held by Holdings had been exchanged for an equal number of shares of our Class A common stock. Since all the partnership units had been exchanged, the Class B common stock was transferred to us and retired on August 31, 2012 in accordance with our certificate of incorporation. These sales and exchanges have resulted in increases in the tax basis of the assets of HFF LP and HFF Securities that have been allocated to HFF, Inc. These increases in tax basis will likely reduce the amount of tax that we would otherwise be required to pay in the future depending on the amount, character and timing of our taxable income, but there can be no assurances that such treatment will continue in the future.

 

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HFF, Inc. entered into a tax receivable agreement with HFF Holdings that provides for the payment by HFF, Inc. to HFF Holdings of 85% of the amount of cash savings, if any, in U.S. federal, state and local income tax that we actually realize as a result of these increases in tax basis and as a result of certain other tax benefits arising from our entering into the tax receivable agreement and making payments under that agreement. For purposes of the tax receivable agreement, cash savings in income tax will be computed by comparing our actual income tax liability to the amount of such taxes that we would have been required to pay had there been no increase to the tax basis of the assets of HFF LP and HFF Securities as a result of the initial sale and later exchanges and had we not entered into the tax receivable agreement. The term of the tax receivable agreement will continue until all such tax benefits have been utilized or expired, including the tax benefits derived from future exchanges.

While the actual amount and timing of payments under the tax receivable agreement will depend upon a number of factors, including the amount and timing of taxable income we generate in the future, the value of our individual assets, the portion of our payments under the tax receivable agreement constituting imputed interest, changes in the tax rates and increases in the tax basis of our assets resulting in payments to HFF Holdings, we expect that the payments that may be made to HFF Holdings will be substantial. The payments under the tax receivable agreement are not conditioned upon HFF Holdings’ or its affiliates’ ownership of us. We may need to incur debt to finance payments under the tax receivable agreement to the extent our cash resources are insufficient to meet our obligations under the tax receivable agreement as a result of timing discrepancies or otherwise.

In addition, although we are not aware of any issue that would cause the Internal Revenue Service (“IRS”) to challenge the tax basis increases or other benefits arising under the tax receivable agreement, HFF Holdings will not reimburse us for any payments previously made if such basis increases or other benefits were later not allowed. As a result, in such circumstances we could make payments to HFF Holdings under the tax receivable agreement in excess of our actual cash tax savings.

Risks Related to Our Class A Common Stock

Ownership by certain of our capital markets advisors of substantial voting power in HFF, Inc. may give rise to conflicts of interests and may prevent new investors from influencing significant corporate decisions.

Members of HFF Holdings, who consist of our senior capital markets advisors as well as other employees of the Operating Partnerships, held in their individual capacity approximately 11% of the voting power in HFF, Inc. as of December 31, 2017. As a result, and in combination with the fact that our certificate of incorporation does not provide for cumulative voting, these individuals, acting as individuals, collectively, have the ability to exert significant influence in the election of the members of our board of directors and thereby the control of our management and affairs, including determinations with respect to acquisitions, dispositions, borrowings, issuances of common stock or other securities, and the declaration and payment of dividends. In addition, these individuals may be able to significantly influence the outcome of all matters requiring stockholder approval, including a change of control of our company or a change in the composition of our board of directors and could preclude any unsolicited acquisition of our company. We cannot assure you that the interests of these individuals will not conflict with your interests.

The concentration of ownership could deprive our Class A stockholders of an opportunity to receive a premium for their shares as part of a sale of the Company and might ultimately affect the market price of our Class A common stock. In addition, as a result of the influence exercised by these individuals over us at any time in the future, we cannot assure you that we would not have received more favorable terms from an unaffiliated party.

If we fail to maintain an effective system of internal controls, we may not be able to accurately report financial results or prevent fraud.

Effective internal controls are necessary to provide reliable financial reports and to assist in the effective prevention of fraud. Any inability to provide reliable financial reports or prevent fraud could harm our business.

 

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We must annually evaluate our internal control procedures to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, which requires management and auditors to assess the effectiveness of internal controls. If we fail to remedy or maintain the adequacy of our internal controls, as such standards are modified, supplemented or amended from time to time, we could be subject to regulatory scrutiny, civil or criminal penalties or shareholder litigation.

In addition, failure to maintain adequate internal controls could result in financial statements that do not accurately reflect our financial condition. There can be no assurance that we will be able to continue to complete the work necessary to fully comply with the requirements of the Sarbanes-Oxley Act or that our management and external auditors will continue to conclude that our internal controls are effective.

If securities analysts do not publish research or reports about our business or if they downgrade our company or our sector, the price of our Class A common stock could decline.

The trading market for our Class A common stock will depend in part on the research and reports that industry or financial analysts publish about us or our business. We do not control these analysts, nor can we assure that any analysts will continue to follow us and issue research reports. Furthermore, if one or more of the analysts who do cover us downgrades our company or our industry, or the stock of any of our competitors, the price of our Class A common stock could decline. If one or more of these analysts ceases coverage of our company, we could lose visibility in the market, which in turn could cause the price of our Class A common stock to decline.

Our share price may decline due to the large number of shares eligible for future sale and for exchange.

The market price of our Class A common stock could decline as a result of sales of a large number of shares of Class A common stock in the market or the perception that such sales could occur. These sales, or the possibility that these sales may occur, also might make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate.

In June 2010, following consultation with our board of directors, 29 members of HFF Holdings agreed to impose resale restrictions on 4,020,640 shares of Class A common stock, a portion of their shares of Class A common stock received in connection with the modification of the Exchange Right and the extension of certain employment agreements with such members of HFF Holdings. In each of March 2015, March 2014 and March 2013, 33%, or approximately 1.34 million of such restricted shares of Class A common stock, became eligible to be freely sold, and as a result, all of the shares received by such members of HFF Holdings in connection with the modification of the Exchange Right and extension of certain employment are agreements are no longer subject to resale restrictions.

As of February 20, 2018, 2,113,693 shares of our Class A common stock were reserved for issuance under outstanding awards of vested and unvested restricted stock units or options to purchase our Class A common stock and 3,292,740 shares of our Class A common stock were reserved for future issuance under our 2016 Equity Incentive Plan.

The market price of our Class A common stock may continue to be volatile, which could cause the value of your investment to decline or subject us to litigation.

Our stock price is affected by a number of factors including, but not limited to, quarterly and annual variations in our results and those of our competitors; changes to the competitive landscape; estimates and projections by the investment community; the arrival or departure of key personnel, especially the retirement or departure of key senior capital markets advisors and management, including members of HFF Holdings and current named executive officers of the Company and senior members of our executive committee and Leadership Team; the introduction of new services by us or our competitors; and acquisitions, strategic alliances

 

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or joint ventures involving us or our competitors. Securities markets worldwide experience significant price and volume fluctuations as has been the case in the past, especially since late 2007 and continuing through 2011. This market volatility, as well as general global and domestic economic, credit and liquidity issues, market or political conditions, has reduced and may reduce in the future the market price of our Class A common stock. In addition, our operating results could be below the expectations of public market analysts and investors, and in response, the market price of our Class A common stock could decrease significantly.

When the market price of a company’s common stock drops significantly, stockholders sometimes institute securities class action lawsuits against the company. A securities class action lawsuit against us could cause us to incur substantial costs and could divert the time and attention of our management and other resources from our business.

Anti-takeover provisions in our charter documents and Delaware law could delay or prevent a change in control.

Our certificate of incorporation and bylaws may delay or prevent a merger or acquisition that a stockholder may consider favorable by permitting our board of directors to issue one or more series of preferred stock, requiring advance notice for stockholder proposals and nominations, providing for a classified board of directors, providing for super-majority votes of stockholders for the amendment of the bylaws and certificate of incorporation, and placing limitations on convening stockholder meetings and not permitting written consents of stockholders. In addition, we are subject to provisions of the Delaware General Corporation Law that restrict certain business combinations with interested stockholders. These provisions may also discourage acquisition proposals or delay or prevent a change in control, which could harm the market price of our Class A common stock.

 

Item 1B.    Unresolved Staff Comments

None.

Item 2.    Properties

Our principal executive offices are located in leased office space at One Victory Park, 2323 Victory Avenue, Suite 1200, Dallas, TX. We also lease or sublease space for our offices in Phoenix, AZ, Charlotte, NC; Philadelphia, PA; Boston, MA; New York, NY; Florham Park, NJ; Washington, D.C.; Miami, FL; Orlando, FL; Tampa, FL; Atlanta, GA; Indianapolis, IN; Chicago, IL; Houston, TX; Pittsburgh, PA; Austin, TX; San Diego, CA; Orange County, CA; Los Angeles, CA; San Francisco, CA; Denver, CO; Portland, OR; London, UK; Seattle, WA; and Las Vegas, NV. The Company operates 25 offices in the U.S. and one in London, UK. We do not own any real property. We believe that our existing facilities will be sufficient for the conduct of our business during the next fiscal year.

Item 3.    Legal Proceedings

We are party to various litigation matters, in most cases involving ordinary course and routine claims incidental to our business. We cannot estimate with certainty our ultimate legal and financial liability with respect to any pending matters. However, we believe, based on our examination of such pending matters, that our ultimate liability for these matters will not have a material adverse effect on our business or financial condition.

Item 4.    Mine Safety Disclosures

Not applicable.

 

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PART II

 

Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Market Information

Our Class A common stock, par value $0.01 per share, trades on the New York Stock Exchange (“NYSE”) under the symbol “HF.” In connection with our initial public offering, our Class A common stock was priced for initial sale on January 30, 2007. There was no established public trading market for our common stock prior to that date. On February 20, 2018 the closing sales price, as reported by the NYSE, was $46.06.

The following table sets forth the high and low sale prices for our Class A common stock as reported by the NYSE for the periods indicated:

 

     2017  
     High      Low  

1st Quarter

   $ 30.91      $ 25.79  

2nd Quarter

     34.95        25.85  

3rd Quarter

     39.76        34.34  

4th Quarter

     49.31        39.33  

 

     2016  
     High      Low  

1st Quarter

   $ 30.72      $ 21.36  

2nd Quarter

     34.39        26.21  

3rd Quarter

     30.47        25.81  

4th Quarter

     32.74        24.84  

For equity compensation plan information, please refer to Item 12 in Part III of the Annual Report on Form 10-K.

Holders

On February 23, 2018, we had 164 stockholders of record of our Class A common stock.

Dividends

On January 26, 2018, our board of directors declared a special cash dividend of $1.75 per share of Class A common stock to stockholders of record on February 9, 2018. The aggregate dividend payment was paid on February 21, 2018 and totaled approximately $67.5 million based on the number of shares of Class A common stock then outstanding. Additionally, 79,387 restricted stock units (dividend equivalent units) were granted for those unvested and vested but not issued restricted stock units as of the record date of February 9, 2018. These dividend units follow the same vesting terms as the underlying restricted stock units. The declaration and payment of any future dividends will be at the sole discretion of our board of directors.

On January 24, 2017, our board of directors declared a special cash dividend of $1.57 per share of Class A common stock to stockholders of record on February 9, 2017. The aggregate dividend payment was paid on February 21, 2017 and totaled approximately $60.0 million based on the number of shares of Class A common stock then outstanding. Additionally, 95,648 restricted stock units (dividend equivalent units) were granted for those unvested and vested but not issued restricted stock units as of the record date of February 9, 2017. These dividend units follow the same vesting terms as the underlying restricted stock units. The declaration and payment of any future dividends will be at the sole discretion of our board of directors.

On January 22, 2016, our board of directors declared a special cash dividend of $1.80 per share of Class A common stock to stockholders of record on February 8, 2016. The aggregate dividend payment was on February 19, 2016 and totaled approximately $68.4 million based on the number of shares of Class A common

 

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stock then outstanding. Additionally, 82,536 restricted stock units (dividend equivalent units) were granted for those unvested and vested but not issued restricted stock units as of the record date of February 8, 2016. These dividend units follow the same vesting terms as the underlying restricted stock units. The declaration and payment of any future dividends will be at the sole discretion of our board of directors.

HFF, Inc. is a holding company and has no material assets other than its ownership of partnership units in the Operating Partnerships and shares of the capital stock in the UK Subsidiaries. If we declare a dividend at some point in the future, we intend to cause the Operating Partnerships to make distributions to HFF, Inc. in an amount sufficient to cover any such dividends. Our ability to declare and pay a dividend will be limited to the extent that the Operating Partnerships are restricted from making such distributions under applicable law or regulation or under any future debt covenants, or are otherwise unable to provide such funds.

Performance Graph

The following graph shows our cumulative total stockholder return for the period December 31, 2012 and ending on December 31, 2017. The graph also shows the cumulative total returns of the Standard & Poor’s 500 Stock Index, or S&P 500 Index, and an industry peer group for this period.

The comparison below assumes $100 was invested on December 31, 2012 in our Class A common stock and in each of the indices shown and assumes that all dividends were reinvested. Our stock price performance shown in the following graph is not indicative of future stock price performance. The peer group is comprised of the following publicly-traded real estate services companies: CB Richard Ellis Group, Inc., and Jones Lang LaSalle Incorporated. These companies represent our primary competitors that are publicly traded with business lines reasonably comparable to ours.

COMPARISON OF 60-MONTH CUMULATIVE TOTAL RETURN

Among HFF, Inc., The S&P 500 Index, and a Peer Group

LOGO

 

     12/31/12      12/31/13      12/31/14      12/31/15      12/31/16      12/31/17  

● HFF, Inc.

     100.00        180.20        254.20        230.42        239.01        406.11  

∎ S&P 500 Index

     100.00        129.60        144.36        143.31        156.98        187.47  

p Peer Group

     100.00        127.41        176.26        155.24        140.52        199.80  

Recent Sales of Unregistered Securities

We did not make any sales of unregistered securities of the Company during 2017.

 

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Issuer Purchases of Equity Securities

None.

 

Item 6. Selected Financial Data

The selected historical consolidated financial data as of and for the years ended December 31, 2017, 2016, and 2015 has been derived from our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The selected historical consolidated financial data for the year ended December 31, 2014 and 2013 was also derived from our audited consolidated financial statements not otherwise included in this Annual Report on Form 10-K. Our historical results are not necessarily indicative of future performance or results of operations. The following selected consolidated financial data should be read in conjunction with Item 7 — “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes thereto appearing in Item 8 “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K.

 

     For The Year Ended December 31,  
     2017     2016     2015     2014     2013  

Statement of Income Data:

          

Total revenues

   $ 609,478     $ 517,426     $ 501,990     $ 425,918     $ 355,605  

Operating expenses

     504,150       421,653       394,217       341,091       285,628  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     105,328       95,773       107,773       84,827       69,977  

Interest and other income, net

     57,209       33,525       32,043       17,926       17,100  

Interest expense

     (21     (42     (47     (41     (33

Decrease (increase) in payable under the tax receivable agreement

     39,212       (1,025     2,143       800       (1,040
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

     201,728       128,231       141,912       103,512       86,004  

Income taxes

     106,768       51,036       57,949       42,226       34,578  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 94,960     $ 77,195     $ 83,963     $ 61,286     $ 51,426  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings per common share

   $ 2.39     $ 1.99     $ 2.18     $ 1.61     $ 1.36  

Cash dividends per common share

   $ 1.57     $ 1.80     $ 1.80     $ 1.83     $  

Adjusted EBITDA (1)

   $ 163,468     $ 133,550     $ 141,263     $ 110,110     $ 96,948  

Balance Sheet Data:

          

Total assets

   $ 892,205     $ 716,659     $ 742,530     $ 604,252     $ 488,176  

Long term debt, excluding current portion

   $ 136     $ 259     $ 514     $ 429     $ 185  

Total liabilities

   $ 605,738     $ 480,117     $ 528,026     $ 417,807     $ 312,602  

 

(1)

The Company defines Adjusted EBITDA as net income before (i) interest expense, (ii) income tax expense, (iii) depreciation and amortization, (iv) stock-based compensation expense, which is a non-cash charge, (v) income recognized on the initial recording of mortgage servicing rights that are acquired with no initial consideration and the inherent value of servicing rights, which are non-cash income amounts, and (vi) the increase or decrease in payable under the tax receivable agreement, which represents changes in a liability recorded on the Company’s consolidated balance sheet determined by the ongoing remeasurement of related deferred tax assets and, therefore, can be income or expense in the Company’s consolidated statement of income in any individual period. The Company uses Adjusted EBITDA in its business operations to, among other things, evaluate the performance of its business, develop budgets and measure its performance against those budgets. The Company also believes that analysts and investors use Adjusted EBITDA as a supplemental measure to evaluate its overall operating performance. However, Adjusted EBITDA has material limitations as an analytical tool and should not be considered in isolation, or as a substitute for analysis of the Company’s results as reported under GAAP. The Company finds Adjusted EBITDA as a useful tool to assist in evaluating performance because it eliminates items related to capital structure and

 

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taxes, including the Company’s tax receivable agreement. Note that the Company classifies the interest expense on its warehouse lines of credit as an operating expense and, accordingly, it is not eliminated from net income in determining Adjusted EBITDA. Some of the items that the Company has eliminated from net income in determining Adjusted EBITDA are significant to the Company’s business. For example, (i) interest expense is a necessary element of the Company’s costs and ability to generate revenue because it incurs interest expense related to any outstanding indebtedness, (ii) payment of income taxes is a necessary element of the Company’s costs, and (iii) depreciation and amortization are necessary elements of the Company’s costs.

Any measure that eliminates components of the Company’s capital structure and costs associated with the Company’s operations has material limitations as a performance measure. In light of the foregoing limitations, the Company does not rely solely on Adjusted EBITDA as a performance measure and also considers its GAAP results. Adjusted EBITDA is not a measurement of the Company’s financial performance under GAAP and should not be considered as an alternative to net income, operating income or any other measures derived in accordance with GAAP. Because Adjusted EBITDA is not calculated in the same manner by all companies, it may not be comparable to other similarly titled measures used by other companies.

Set forth below is an unaudited reconciliation of consolidated net income to Adjusted EBITDA for the Company for the periods set forth below:

Adjusted EBITDA for the Company is calculated as follows:

(dollars in thousands)

     For the year ended December 31,  
     2017     2016     2015     2014     2013  

Net income

   $ 94,960     $ 77,195     $ 83,963     $ 61,286     $ 51,426  

Add:

          

Interest expense

     21       42       47       41       33  

Income tax expense

     106,768       51,036       57,949       42,226       34,578  

Depreciation and amortization

     17,001       11,834       9,194       7,830       6,800  

Stock-based compensation (a)

     17,385       12,310       8,579       9,821       8,302  

Valuation of mortgage servicing rights

     (33,455     (19,892     (16,326     (10,294     (5,231

Change in payable under the tax receivable agreement

     (39,212     1,025       (2,143     (800     1,040  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

   $ 163,468     $ 133,550     $ 141,263     $ 110,110     $ 96,948  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(a)

Amounts do not reflect expense associated with the stock component of estimated incentive payouts under the Company’s Firm Profit Participation Plan or Office Profit Participation Plans and effective January 1, 2015, the Company’s executive bonus plan (the “Executive Bonus Plan” and collectively, the “Plans”) that are anticipated to be paid in respect of the applicable year. Such expense is recorded as incentive compensation expense within personnel expenses in the Company’s consolidated statements of comprehensive income during the year to which the expense relates. Following the award, if any, of the related incentive payout, the stock component is reclassified as stock compensation costs within personnel expenses. See Note 2 to the Company’s consolidated financial statements for further information regarding the Company’s accounting policies relating to its Plans.

Stock-based compensation expense for the years ended December 31, 2017, 2016, 2015, 2014 and 2013 reflects $3.3 million, $4.1 million, $2.3 million, $1.9 million and $1.2 million respectively, of expense recognized during such period that was associated with restricted stock units granted in the first quarter of each respective year under the Plans in respect of 2016, 2015, 2014, 2013 and 2012 activity, respectively.

See Note 3 to the Company’s consolidated financial statements for further information regarding the Company’s stock compensation.

 

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Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the Selected Financial Data and our audited consolidated financial statements and the accompanying notes thereto included elsewhere herein. The following discussion is based on the consolidated results of HFF, Inc. In addition to historical information, the following discussion also contains forward-looking statements that include risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those factors set forth under Item 1A — “Risk Factors” of this Annual Report on Form 10-K.

Overview

Our Business

We are, based on transaction volume, one of the leading providers of commercial real estate and capital markets services to both the users and providers of capital in the commercial real estate industry and are one of the largest full-service commercial real estate financial intermediaries in the country. We operate out of 26 offices with approximately 982 associates and approximately 371 capital markets advisors. During 2017, we advised on approximately $96.1 billion of completed commercial real estate transactions, a 17.1% increase compared to the approximately $82.0 billion of completed transactions we advised on in 2016.

Substantially all of our revenues are in the form of capital markets services fees collected from our clients, usually negotiated on a transaction-by-transaction basis. We also earn fees from commercial loan servicing activities. We believe that our multiple product offerings, diverse client mix, expertise in a wide range of property types and national platform have the potential to create a diversified revenue stream within the U.S. commercial real estate sector. Our revenues and net income were $609.5 million and $95.0 million, respectively, for the year ended December 31, 2017, compared to revenues and net income of $517.4 million and $77.2 million, respectively, for the year ended December 31, 2016.

Our business may be significantly affected by factors outside of our control, particularly including:

 

   

Economic and commercial real estate market downturns.    Our business is dependent on international and domestic economic conditions and the demand for commercial real estate and related services in the markets in which we operate. A slow-down, a significant downturn or a recession in either the global economy or the domestic economy including, but not limited to, even a regional economic downturn, could adversely affect our business. A general decline in acquisition and disposition activity, as well as a general decline in commercial real estate investment activity, can lead to a reduction in fees and commissions for arranging such transactions, as well as in fees and commissions for arranging financing for acquirers and property owners that are seeking to recapitalize their existing properties. Such a general decline can also lead to a significant reduction in our loan servicing activities, due to increased delinquencies and defaults and lack of additional loans that we would have otherwise added to our loan servicing portfolio. Additionally, evolving global regulatory and compliance trends, including changes to the UK regulatory framework resulting from the UK’s exit from the European Union, may adversely affect our business and the economic and commercial real estate markets in which we do business.

 

   

Global and domestic credit and liquidity issues.    Global and domestic credit and liquidity issues have in the recent past led to an economic downturn, including a commercial real estate market downturn. This downturn led to a decrease in transaction activity and lower values. Restrictions on the availability of capital, both debt and/or equity, created significant reductions, and could in the future create further reductions of the liquidity in and flow of capital to the commercial real estate markets. These restrictions also caused, and could in the future cause, commercial real estate prices to decrease due to the reduced amount of equity capital and debt financing available.

 

   

Decreased investment allocation to commercial real estate class.    Allocations to commercial real estate as an asset class for investment portfolio diversification may decrease for a number of reasons beyond our control including, but not limited to, poor performance of the asset class relative to other asset classes or

 

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the superior performance of other asset classes when compared with continued good performance of the commercial real estate asset class or the poor performance of all asset classes. In addition, while commercial real estate is now viewed as an accepted and valid class for portfolio diversification, if this perception changes, there could be a significant reduction in the amount of debt and equity capital available in the commercial real estate sector.

 

   

Fluctuations in interest rates.    Significant fluctuations in interest rates as well as steady and protracted movements of interest rates in one direction (increases or decreases) could adversely affect the operation and income of commercial real estate properties, as well as the demand from investors for commercial real estate investments. Both of these events could adversely affect investor demand and the supply of capital for debt and equity investments in commercial real estate. In particular, increased interest rates may cause prices to decrease due to the increased costs of obtaining financing and could lead to decreases in purchase and sale activities, thereby reducing the amounts of investment advisory and loan originations and related servicing fees. If our debt placement and investment advisory originations and servicing businesses are negatively impacted, it is likely that our other lines of business would also suffer due to the relationship among our various capital markets services.

The factors discussed above have adversely affected and continue to be a risk to our business, as evidenced by the effects of the significant disruptions during 2007 through 2010 to the global capital and credit markets, and in particular the domestic capital markets. The global and domestic credit and liquidity issues and reductions in debt and equity allocations to commercial real estate reduced, and could in the future reduce, the number of acquisitions, dispositions and loan originations, as well as the respective number of transactions, which could in turn adversely affect our capital markets services revenues including our servicing revenue. While conditions have generally improved, global and domestic credit and liquidity issues, economic recessions or slowdowns and other global and domestic macro events beyond our control, could have a significant adverse effect on our capital markets services revenues (including, but not limited to, our servicing revenues). The significant balance sheet issues of many CMBS lenders, banks, life insurance companies, mortgage REITS and debt funds, captive finance companies and other financial institutions have adversely affected, and could again in the future adversely affect, the flow of commercial mortgage debt to the U.S. capital markets, and, in turn, could potentially adversely affect all of our capital markets services platforms and resulting revenues.

Other factors that may adversely affect our business are discussed under the heading “Forward-Looking Statements” and under the caption “Risk Factors” in this Annual Report on Form 10-K.

Key Financial Measures and Indicators

Revenues

Substantially all of our revenues are derived from capital markets services. These capital markets services revenues are in the form of fees collected from our clients, usually negotiated on a transaction-by-transaction basis, which includes origination fees, investment advisory fees earned for brokering sales of commercial real estate, loan servicing fees and loan sales and other production fees. We also earn interest on mortgage notes receivable during the period between the origination of the loan and the subsequent sale to Freddie Mac in connection with our participation in the Freddie Mac Program. For the year ended December 31, 2017, we had total revenues of $609.5 million, of which approximately 96.2% were attributable to capital markets services revenue, 3.1% were attributable to interest on mortgage notes receivable and 0.7% were attributable to other revenue sources. For the year ended December 31, 2016, our total revenues equaled $517.4 million, of which 96.4% were generated by our capital markets services, 2.9% were attributable to interest on mortgage notes receivable and 0.7% were attributable to other revenue sources.

 

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Total Revenues:

Capital markets services revenues.    We earn our capital markets services revenue through the following activities and sources:

 

   

Origination fees.    Our origination fees are earned through the placement of debt and equity. Debt placements (along with investment advisory fees — see below) represent the majority of our business, with approximately $51.7 billion and $40.7 billion of debt transaction volume in 2017 and 2016, respectively. Fees earned by the Securities Subsidiaries for discretionary and non-discretionary equity capital raises and other investment banking services are also included with capital markets services revenue in our consolidated statements of comprehensive income. We recognize origination revenues at the closing of the applicable financing and funding of capital, when such fees are generally collected. We recognize fees earned by Securities Subsidiaries at the time the capital is funded or committed and the fee is fixed or determinable, based on the underlying fee agreement, unless collectibility of our fee is not reasonably assured, in which case we recognize fees as they are collected.

 

   

Investment advisory fees.    We earn investment advisory fees by acting as a broker for commercial real estate owners seeking to sell a property or multiple properties or an interest in a property or multiple properties. We recognize investment advisory revenues at the close and funding of the sale, when such fees are generally collected.

 

   

Loan servicing fees.    We generate loan servicing fees through the provision of collection, remittance, recordkeeping, reporting and other related loan servicing functions, activities and services. We recognize loan servicing revenues at the time services are rendered, provided the loans are current and the debt service payments are actually made by the borrowers.

 

   

Loan sales and other production fees.    We generate loan sales and other production fees through assisting our clients in their efforts to sell all or portions of commercial real estate debt notes. We recognize loan sales and other production revenues at the close and funding of the capital to consummate a sale, when such fees are generally collected.

Interest on mortgage notes receivable.    We recognize interest income on the accrual basis during the holding period based on the contract interest rate in the loan that is to be purchased by Freddie Mac in connection with our participation in the Freddie Mac Program, provided that the debt service is paid by the borrower.

Other.    Our other revenues include expense reimbursements from clients related to out-of-pocket costs incurred, which reimbursements are considered revenue for accounting purposes.

A substantial portion of our transactions are success based, with a small percentage including retainer fees (such retainer fees typically being included in a success-based fee upon the closing of a transaction) and/or breakage fees. Transactions that are terminated before completion will sometimes generate breakage fees, which are usually calculated as a set amount or a percentage (which varies by deal size and amount of work done at the time of breakage) of the fee we would have received had the transaction closed. The amount and timing of all of the fees paid vary by the type of transaction and are generally negotiated on a transaction-by-transaction basis.

Costs and Expenses

The largest components of our expenses are our operating expenses, which consist of cost of services, personnel expenses not directly attributable to providing services to our clients, occupancy expenses, travel and entertainment expenses, supplies, research and printing expenses and other expenses. For the years ended December 31, 2017 and 2016, our total operating expenses were $504.2 million and $421.7 million, respectively.

 

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Operating Expenses:

Cost of Services.    The largest portion of our operating expenses is cost of services. We consider employee expenses directly attributable to providing services to our clients and certain purchased services to be directly attributable to the generation of our capital markets services revenue, and classify these expenses as cost of services in the consolidated statements of comprehensive income. These employee expenses include employee-related compensation and benefits. Most of our capital markets advisors are paid commissions; however, there are some capital markets advisors who are initially paid a salary or draw with commissions credited against the salary or draw. Additionally, some capital markets advisors are paid super-commissions (as defined in their respective employment contracts) based on successfully achieved contractual performance based metrics. Analysts, who support capital markets advisors in executing transactions, are paid a salary plus a discretionary bonus, which is usually calculated as a percentage of an analyst bonus pool or as direct bonuses for each transaction, depending on the policy of each office. All other employees may receive a combination of salary and an incentive bonus based on performance or job function.

Personnel.     Personnel expenses include employee-related compensation and benefits that are not directly attributable to providing services to our clients including, profit participation bonuses, stock based compensation and any other incentive bonus compensation. Offices or lines of business that generate profit margins of 14.5% or more are entitled to profit participation bonuses equal to 15% of adjusted operating income (as defined in the Office Profit Participation Plans) generated by the office or line of business. The allocation of the payment associated with the Office Profit Participation Plans to the employees is determined by the office head with a review by the managing member of HFF LP or HFF Securities, as the case may be, provided that any profit participation bonuses to be paid to any executive officer or inside director of HFF, Inc. must be approved in advance by our board of directors or an appropriate committee thereof. In 2017 and 2016, the total expense related to the Office Profit Participation Plans was approximately 15.7% and 13.6% respectively of operating income before the Office and Firm Profit Participation Plan expense. This increased percentage is primarily due to the amended vesting conditions of the Office Profit Participation Plans. Due to the amended vesting conditions within the Office Profit Participation Plans effective January 1, 2015, approximately 12%, 12%, 12% and 2% of the 2017 total bonus amount is expected to be expensed in 2018, 2019, 2020 and 2021, respectively.

In addition, in January 2011, we adopted the HFF, Inc. Firm Profit Participation Plan. For each calendar year, beginning in 2011, if we achieve a 17.5% or greater adjusted operating income margin (as defined under such plan), a bonus pool is funded by a percentage, ranging from 15% to 25%, of our adjusted operating income (as defined under such plan) beyond predefined adjusted operating income margin thresholds ranging from 17.5% to 27.5%. Members of the executive and leadership committees of the Operating Partnerships, as well as others within the Operating Partnerships, are eligible to receive a bonus payment under the Firm Profit Participation Plan. The Firm Profit Participation Plan is administered by our chief executive officer, provided that any profit participation bonuses to be paid to any executive officer or inside director of HFF, Inc. must be approved in advance by our board of directors or an appropriate committee thereof. In 2017 and 2016, total Firm Profit Participation Plan expense was approximately 5.6% and 4.6% of operating income before the Firm Profit Participation Plan expense. Due to the amended vesting conditions within the Firm Profit Participation Plan effective January 1, 2015, approximately 12%, 12%, 12% and 2% of the 2017 total bonus amount is expected to be expensed in 2018, 2019, 2020 and 2021, respectively.

Stock Based Compensation.    The Company applies the provisions of ASC 718, Compensation — Stock Compensation (ASC 718), to account for the Company’s share-based compensation. ASC 718 requires the measurement and recognition of compensation expense for all stock-based payment awards made to employees and directors, including employee stock options and other forms of equity compensation based on estimated fair values. The Company estimates the grant-date fair value of stock options using the Black-Scholes option-pricing model. The Company has not granted any stock options since 2010. The fair value of the restricted stock unit awards is calculated as the market value of the Company’s Class A common stock on the date of grant. The Company’s awards are subject to graded or cliff vesting. Compensation expense is adjusted for forfeitures as they occur and is recognized on a straight-line basis over the requisite service period of the award.

 

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Expense associated with the stock component of estimated incentive payouts under the Company’s Firm Profit Participation Plan, Office Profit Participation Plans or Executive Bonus Plan that are anticipated to be paid in respect of the applicable year is recorded as incentive compensation expense within personnel expenses in the Company’s consolidated statements of comprehensive income during the year to which the expense relates. Following the award, if any, of the related incentive payout, the stock component expense is reclassified as stock compensation costs within personnel expenses. See Note 2 to the Company’s consolidated financial statements for further information regarding the Company’s accounting policies relating to its Firm Profit Participation Plan, Office Profit Participation Plans and Executive Bonus Plan.

Occupancy.     Occupancy expenses include rental expenses and other expenses related to our offices.

Travel and entertainment.    Travel and entertainment expenses include travel and other entertainment expenses incurred in conducting our business activities.

Supplies, research and printing.    Supplies, research and printing expenses represent expenses related to office supplies, market and other research and printing.

Other.    The balance of our operating expenses includes costs for insurance, professional fees, depreciation and amortization, interest on our warehouse line of credit and other operating expenses.

Interest and Other Income, net:

Interest and other income, net consists of income recognized on the initial recording of mortgage servicing rights that are acquired with no initial consideration and the inherent value of servicing rights, gains on the sale of loans, gains on the sale of mortgage servicing rights, securitization compensation from the sale of mortgage servicing rights that were part of a securitization pool, trading profits on certain Fannie Mae loans and interest earned from the investment of our cash and cash equivalents.

Interest Expense:

Interest expense represents the interest on our outstanding debt instruments.

Decrease (Increase) in Payable Under the Tax Receivable Agreement:

The increase or decrease in the payable under the tax receivable agreement represents the increase or decrease in the estimated tax benefits owed to HFF Holdings under the tax receivable agreement due to a change in the effective tax rate used to value the deferred tax benefit and any changes in the valuation allowance on the deferred tax assets. This increase or decrease in tax benefits owed to HFF Holdings represents 85% of the increase or decrease in the related deferred tax asset.

Income Tax Expense:

The Company accounts for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and for tax losses and tax credit carryforwards, if any. Deferred tax assets and liabilities are measured using tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates will be recognized in income in the period of the tax rate change. In assessing the realizability of deferred tax assets, the Company considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized.

The 2017 Tax Act significantly revises the U.S. corporate income tax by, among other things, lowering the statutory corporate tax rate from 35% to 21%, eliminating certain deductions, imposing a mandatory one-time tax on accumulated earnings of foreign subsidiaries, introducing new tax regimes, and changing how foreign

 

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earnings are subject to U.S. tax. The 2017 Tax Act also enhanced and extended through 2026 the option to claim accelerated depreciation deductions on qualified property. We have not completed our determination of the accounting implications of the 2017 Tax Act on our tax accruals. However, we have reasonably estimated the effects of the 2017 Tax Act and recorded provisional amounts in our financial statements as of December 31, 2017. As we complete our analysis of the 2017 Tax Act, collect and prepare necessary data, and interpret any additional guidance issued by the U.S. Treasury Department, the IRS, and other standard-setting bodies, we may make adjustments to the provisional amounts. Those adjustments may materially impact our provision for income taxes in the period in which the adjustments are made.

Our effective tax rate is sensitive to several factors including changes in the mix of our geographic profitability. We evaluate our estimated tax rate on a quarterly basis to reflect changes in: (i) our geographic mix of income, (ii) legislative actions on statutory tax rates and (iii) tax planning for jurisdictions affected by double taxation. We continually seek to develop and implement potential strategies and/or actions that would reduce our overall effective tax rate.

 

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Results of Operations

Following is a discussion of our results of operation for the years ended December 31, 2017, 2016 and 2015. The tables included in the period comparisons below provide summaries of our results of operations. The period-to-period comparisons of financial results are not necessarily indicative of future results.

Year Ended December 31, 2017 Compared to Year Ended December 31, 2016

 

     For The Year Ended December 31,               
     2017     2016    

Total

Dollar

    

Total

Percentage

 
           % of           % of       
     Dollars     Revenue     Dollars     Revenue     Change      Change  
     (Dollars in thousands)  

Revenues

             

Capital markets services revenue

   $ 586,346       96.2   $ 498,590       96.4   $ 87,756        17.6

Interest on mortgage notes receivable

     19,114       3.1     15,198       2.9     3,916        25.8

Other

     4,018       0.7     3,638       0.7     380        10.4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total revenues

     609,478       100.0     517,426       100.0     92,052        17.8

Operating expenses

             

Cost of services

     342,208       56.1     291,290       56.3     50,918        17.5

Personnel

     62,174       10.2     51,171       9.9     11,003        21.5

Occupancy

     16,165       2.7     14,133       2.7     2,032        14.4

Travel and entertainment

     19,507       3.2     16,786       3.2     2,721        16.2

Supplies, research and printing

     8,934       1.5     7,700       1.5     1,234        16.0

Other

     55,162       9.1     40,573       7.8     14,589        36.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total operating expenses

     504,150       82.7     421,653       81.5     82,497        19.6
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Operating income

     105,328       17.3     95,773       18.5     9,555        10.0

Interest and other income, net

     57,209       9.4     33,525       6.5     23,684        70.6

Interest expense

     (21     0.0     (42     0.0     21        (50.0 )% 

Decrease (increase) in payable under the tax receivable agreement

     39,212       6.4     (1,025     (0.2 )%      40,237        *
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Income before taxes

     201,728       33.1     128,231       24.8     73,497        57.3

Income tax expense

     106,768       17.5     51,036       9.9     55,732        109.2
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net income

   $ 94,960       15.6   $ 77,195       14.9   $ 17,765        23.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Adjusted EBITDA (1)

   $ 163,468       26.8   $ 133,550       25.8   $ 29,918        22.4

 

** -

Results of calculation are not considered meaningful for presentation purposes.

 

(1)

The Company defines Adjusted EBITDA as net income before (i) interest expense, (ii) income tax expense, (iii) depreciation and amortization, (iv) stock-based compensation expense, which is a non-cash charge, (v) income recognized on the initial recording of mortgage servicing rights that are acquired with no initial consideration and the inherent value of servicing rights, which are non-cash income amounts, and (vi) the increase or decrease in payable under the tax receivable agreement, which represents changes in a liability recorded on the Company’s consolidated balance sheet determined by the ongoing remeasurement of related deferred tax assets and, therefore, can be income or expense in the Company’s consolidated statement of income in any individual period.

The Company uses Adjusted EBITDA in its business operations to, among other things, evaluate the performance of its business, develop budgets and measure its performance against those budgets. The Company also believes that analysts and investors use Adjusted EBITDA as a supplemental measure to

 

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evaluate its overall operating performance. However, Adjusted EBITDA has material limitations as an analytical tool and should not be considered in isolation, or as a substitute for analysis of the Company’s results as reported under GAAP. The Company finds Adjusted EBITDA as a useful tool to assist in evaluating performance because it eliminates items related to capital structure and taxes, including the Company’s tax receivable agreement. Note that the Company classifies the interest expense on its warehouse lines of credit as an operating expense and, accordingly, it is not eliminated from net income in determining Adjusted EBITDA. Some of the items that the Company has eliminated from net income in determining Adjusted EBITDA are significant to the Company’s business. For example, (i) interest expense is a necessary element of the Company’s costs and ability to generate revenue because it incurs interest expense related to any outstanding indebtedness, (ii) payment of income taxes is a necessary element of the Company’s costs, and (iii) depreciation and amortization are necessary elements of the Company’s costs.

Any measure that eliminates components of the Company’s capital structure and costs associated with the Company’s operations has material limitations as a performance measure. In light of the foregoing limitations, the Company does not rely solely on Adjusted EBITDA as a performance measure and also considers its GAAP results. Adjusted EBITDA is not a measurement of the Company’s financial performance under GAAP and should not be considered as an alternative to net income, operating income or any other measures derived in accordance with GAAP. Because Adjusted EBITDA is not calculated in the same manner by all companies, it may not be comparable to other similarly titled measures used by other companies.

Revenues.    Our total revenues were $609.5 million for the year ended December 31, 2017 compared to $517.4 million for the same period in 2016, an increase of $92.1 million, or 17.8%. Revenues increased primarily as a result of a 17.1% increase in production volumes in a majority of our capital markets services platforms.

 

   

The revenues we generated from capital markets services for the year ended December 31, 2017 increased $87.8 million, or 17.6%, to $586.3 million from $498.6 million for the same period in 2016. The increase is primarily attributable to the 17.1% increase in production volumes.

 

   

The revenues derived from interest on mortgage notes receivable was $19.1 million for the year ended December 31, 2017 compared to $15.2 million for the same period in 2016, an increase of $3.9 million, or 25.8%. The increase is due to originating a larger number of loans at higher interest rates in conjunction with our participation in the Freddie Mac Program during 2017 as compared to 2016.

 

   

The other revenues we earned, which include expense reimbursements from clients related to out-of-pocket costs incurred and vary on a transaction-by-transaction basis, were $4.0 million for the year ended December 31, 2017 compared to $3.6 million for the same period in 2016, an increase of approximately $0.4 million, or 10.4%.

Total Operating Expenses.    Our total operating expenses were $504.2 million for the year ended December 31, 2017 compared to $421.7 million for the same period in 2016, an increase of $82.5 million, or 19.6%. Expenses increased primarily due to increased compensation-related costs within cost of services and personnel costs as a result of increases in commissions and other incentive compensation directly related to the increase in capital markets services revenue, an increase in headcount and an increase in performance-based compensation. Additionally, due to the increased production volume and headcount, we experienced increased expenses for travel and entertainment and occupancy.

 

   

The costs of services for the year ended December 31, 2017 increased approximately $50.9 million, or 17.5%, to $342.2 million from $291.3 million for the same period in 2016. The increase is primarily the result of the increase in commissions and other incentive compensation directly related to the 17.6% increase in capital markets services revenues. Additionally, contributing to the increase in cost of services are higher salary and fringe benefit costs from increased headcount to support the increase in production volume. Cost of services as a percentage of capital markets services revenues were approximately 58.4% for the years ended December 31, 2017 and 2016.

 

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Personnel expenses that are not directly attributable to providing services to our clients for the year ended December 31, 2017 increased $11.0 million, or 21.5%, to $62.2 million from $51.2 million for the same period in 2016. The increase is primarily related to an increase in salaries and benefit costs. Personnel expenses are impacted quarterly by the adjustments made to accrue for the estimated expense associated with the performance based Firm and Office Profit Participation Plans. Both the Firm and Office Profit Participation Plans allow for payments in the form of both cash and share-based awards based on the decision of the Company’s board of directors. These increases in personnel expenses were driven by an increase in stock compensation (excluding stock compensation relating to the Firm and Office Profit Participation Plans) of $2.4 million.

Stock compensation expense, which is included in personnel expenses, for the year ended December 31, 2017 was $17.4 million as compared to $12.3 million for the same period in 2016, an increase of $5.1 million. This increase was driven by an increase in stock compensation costs of $2.7 million related to the profit participation awards. At December 31, 2017, there was approximately $32.6 million of unrecognized compensation cost related to share-based awards. The weighted average remaining contractual term of the unvested restricted stock units is 2.0 years as of December 31, 2017.

 

   

Occupancy and travel and entertainment expenses for the year ended December 31, 2017 increased $4.8 million, or 15.4%, to $35.7 million compared to $30.9 million the same period in 2016. This increase is primarily due to increased occupancy costs associated with our increased headcount and travel and entertainment costs stemming from the increase in capital markets services revenues.

 

   

Other expenses, including costs for insurance, professional fees, depreciation and amortization, interest on our warehouse line of credit and other operating expenses, were $55.2 million in the year ended December 31, 2017, an increase of $14.6 million, or 36.0%, compared to $40.6 million in the year ended December 31, 2016. This increase is primarily related to an increase in our interest expense on our warehouse lines of credit supporting our participation in the Freddie Mac Program business of $5.2 million, an increase of $2.4 million in other operating expenses, and an increase of $5.2 million in depreciation and amortization.

Operating income.    Our operating income in 2017 was $105.3 million, an increase of $9.6 million from $95.8 million in 2016 attributable to the factors discussed above.

Interest and other income, net.    Interest and other income, net in 2017 increased $23.7 million, or 70.6%, to $57.2 million from $33.5 million in 2016. This increase was primarily due to an increase in the valuation of servicing rights of $13.6 million along with increases of $10.0 million in securitization compensation.

Interest expense.    The interest expense we incurred during the year ended December 31, 2017 totaled $21,000 compared to $42,000 of similar expenses incurred in the year ended December 31, 2016.

Net Income.    Our net income for the year ended December 31, 2017 was $95.0 million, an increase of $17.8 million, or 23.0%, compared to $77.2 million for the same fiscal period in 2016. In addition to the factors affecting operating income, interest and other income, net and interest expense discussed above, other factors impacting net income included:

 

   

Changes in the estimated tax benefits owed to HFF Holdings under the tax receivable agreement as we are obligated to pay HFF Holdings 85% of cash savings, if any, in U.S. federal, state and local income tax that we realize as a result of the increase in tax basis pursuant to our election under Section 754. We had a reduction in the payable under the tax receivable agreement of $39.2 for the year ended December 31, 2017 compared to an increase in the payable under the tax receivable agreement of $1.0 million for the year ended December 31, 2016. The reduction during 2017 was principally impacted during the fourth quarter as a result of the reduction in statutory tax rates associated with the 2017 Tax Act. Each year we update the tax rates used to measure the deferred tax assets which resulted in a decrease in deferred tax

 

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assets related to the payable under the tax receivable agreement of $46.1 million and $1.2 million for 2017 and 2016, respectively.

 

   

Income tax expense was approximately $106.8 million for the year ended December 31, 2017, an increase of approximately $55.7 million over $51.0 million for the year ended December 31, 2016. Including the $39.2 million associated to the reduction in the payable under the tax receivable agreement, income before taxes increased $73.5 million as compared to 2016. The increase in income before taxes as well as the expense associated with the reduction in deferred tax assets as a result of the 2017 Tax Act resulted in additional income taxes in 2017. During the year ended December 31, 2017, the Company recorded current income tax expense of $45.1 million and deferred income tax expense of approximately $61.7 million. During the year ended December 31, 2016, the Company recorded current income tax expense of $34.5 million and a deferred income tax expense of $16.5 million. For further detail relating to the Operating Partnerships’ tax basis step-up election under Section 754, refer to Note 13 to our consolidated financial statements.

Year Ended December 31, 2016 Compared to Year Ended December 31, 2015

 

     For The Year Ended December 31,              
     2016     2015    

Total

Dollar

   

Total

Percentage

 
           % of           % of      
     Dollars     Revenue     Dollars     Revenue     Change     Change  
     (Dollars in thousands)  

Revenues

            

Capital markets services revenue

   $ 498,590       96.4   $ 487,941       97.2   $ 10,649       2.2

Interest on mortgage notes receivable

     15,198       2.9     11,205       2.2     3,993       35.6

Other

     3,638       0.7     2,844       0.6     794       27.9
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     517,426       100.0     501,990       100.0     15,436       3.1

Operating expenses

            

Cost of services

     291,290       56.3     280,674       55.9     10,616       3.8

Personnel

     51,171       9.9     47,732       9.5     3,439       7.2

Occupancy

     14,133       2.7     12,236       2.4     1,897       15.5

Travel and entertainment

     16,786       3.2     14,644       2.9     2,142       14.6

Supplies, research and printing

     7,700       1.5     7,769       1.5     (69     (0.9 )% 

Other

     40,573       7.8     31,162       6.2     9,411       30.2
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     421,653       81.5     394,217       78.5     27,436       7.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     95,773       18.5     107,773       21.5     (12,000     (11.1 )% 

Interest and other income, net

     33,525       6.5     32,043       6.4     1,482       4.6

Interest expense

     (42     0.0     (47     0.0     5       (10.6 )% 

(Increase) decrease in payable under the tax receivable agreement

     (1,025     (0.2 )%      2,143       0.4     (3,168     (147.8 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before taxes

     128,231       24.8     141,912       28.3     (13,681     (9.6 )% 

Income tax expense

     51,036       9.9     57,949       11.5     (6,913     (11.9 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 77,195       14.9   $ 83,963       16.7   $ (6,768     (8.1 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA (1)

   $ 133,550       25.8   $ 141,263       28.1   $ (7,713     (5.5 )% 

 

(1)

The Company defines Adjusted EBITDA as net income before (i) interest expense, (ii) income tax expense, (iii) depreciation and amortization, (iv) stock-based compensation expense, which is a non-cash charge, (v) income recognized on the initial recording of mortgage servicing rights that are acquired with no initial consideration and the inherent value of servicing rights, which are non-cash income amounts, and (vi) the increase or decrease in payable under the tax receivable agreement, which represents changes in a liability

 

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recorded on the Company’s consolidated balance sheet determined by the ongoing remeasurement of related deferred tax assets and, therefore, can be income or expense in the Company’s consolidated statement of income in any individual period. The Company uses Adjusted EBITDA in its business operations to, among other things, evaluate the performance of its business, develop budgets and measure its performance against those budgets. The Company also believes that analysts and investors use Adjusted EBITDA as supplemental measures to evaluate its overall operating performance. However, Adjusted EBITDA has material limitations as an analytical tool and should not be considered in isolation, or as a substitute for analysis of the Company’s results as reported under GAAP. The Company finds Adjusted EBITDA as a useful tool to assist in evaluating performance because it eliminates items related to capital structure and taxes, including, the Company’s tax receivable agreement. Note that the Company classifies the interest expense on its warehouse lines of credit as an operating expense and, accordingly, it is not eliminated from net income attributable to controlling interest in determining Adjusted EBITDA. Some of the items that the Company has eliminated from net income attributable to controlling interest in determining Adjusted EBITDA are significant to the Company’s business. For example, (i) interest expense is a necessary element of the Company’s costs and ability to generate revenue because it incurs interest expense related to any outstanding indebtedness, (ii) payment of income taxes is a necessary element of the Company’s costs and (iii) depreciation and amortization are necessary elements of the Company’s costs.

Any measure that eliminates components of the Company’s capital structure and costs associated with the Company’s operations has material limitations as a performance measure. In light of the foregoing limitations, the Company does not rely solely on Adjusted EBITDA as a performance measure and also considers its GAAP results. Adjusted EBITDA is not a measurement of the Company’s financial performance under GAAP and should not be considered as an alternative to net income, operating income or any other measures derived in accordance with GAAP. Because Adjusted EBITDA is not calculated in the same manner by all companies, it may not be comparable to other similarly titled measures used by other companies.

Revenues.    Our total revenues were $517.4 million for the year ended December 31, 2016 compared to $502.0 million for the same period in 2015, an increase of $15.4 million, or 3.1%. Revenues increased primarily as a result of a 7.9% increase in production volumes and related revenues in a majority of our capital markets services platforms.

 

   

The revenues we generated from capital markets services for the year ended December 31, 2016 increased $10.6 million, or 2.2%, to $498.6 million from $487.9 million for the same period in 2015. The increase is primarily attributable to the 7.9% increase in production volumes.

 

   

The revenues derived from interest on mortgage notes receivable was $15.2 million for the year ended December 31, 2016 compared to $11.2 million for the same period in 2015, an increase of $4.0 million, or 35.6%. The increase is due to holding the loans for a longer period of time in conjunction with our participation in the Freddie Mac Program during 2016 as compared to 2015.

 

   

The other revenues we earned, which include expense reimbursements from clients related to out-of-pocket costs incurred and vary on a transaction-by-transaction basis, were $3.6 million for the year ended December 31, 2016 compared to $2.8 million for the same period in 2015, an increase of approximately $0.8 million, or 27.9%.

 

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Total Operating Expenses.    Our total operating expenses were $421.7 million for the year ended December 31, 2016 compared to $394.2 million for the same period in 2015, an increase of $27.4 million, or 7.0%. Expenses increased primarily due to increased compensation-related costs within cost of services and personnel costs as a result of increases in commissions and other incentive compensation directly related to the increase in capital markets services revenue, an increase in headcount and an increase in performance-based compensation. Additionally, due to the increased production volume and headcount, we experienced increased expenses for travel and entertainment and occupancy.

 

   

The costs of services for the year ended December 31, 2016 increased approximately $10.6 million, or 3.8%, to $291.3 million from $280.7 million for the same period in 2015. The increase is primarily the result of the increase in commissions and other incentive compensation directly related to the 2.2% increase in capital markets services revenues. Additionally, contributing to the increase in cost of services are higher salary and fringe benefit costs from increased headcount to support the increase in production volume. Cost of services as a percentage of capital markets services revenues were approximately 58.4% and 57.5% for the years ended December 31, 2016 and December 31, 2015, respectively. This percentage increase in 2016 is primarily attributable to the fixed portion of cost of services, such as salaries for our analysts and fringe benefit costs, increasing at a higher percentage than the increase in capital markets services revenues.

 

   

Personnel expenses that are not directly attributable to providing services to our clients for the year ended December 31, 2016 increased $3.4 million, or 7.2%, to $51.2 million from $47.7 million for the same period in 2015. The increase is primarily related to an increase in salaries and benefit costs. Offsetting this increase is a $3.0 million decrease in the 2016 Firm and Office Profit Participation Plans expense resulting from the lower operating income during the year ended December 31, 2016. Personnel expenses are impacted quarterly by the adjustments made to accrue for the estimated expense associated with the performance based Firm and Office Profit Participation Plans. Both the Firm and Office Profit Participation Plans allow for payments in the form of both cash and share-based awards based on the decision of the Company’s board of directors. These increases in personnel expenses were driven by an increase in stock compensation (excluding stock compensation relating to the Firm and Office Profit Participation Plans) of $3.7 million.

The stock compensation expense, which is included in personnel expenses, for the year ended December 31, 2016 was $12.3 million as compared to $8.6 million for the same period in 2015, an increase of $3.7 million. This increase was driven by an increase in stock compensation costs of $1.3 million related to the profit participation awards. This increase was additionally due to restricted stock unit awards granted in February 2016, of which there was no such cost in 2015. At December 31, 2016, there was approximately $28.7 million of unrecognized compensation cost related to share-based awards. The weighted average remaining contractual term of the unvested restricted stock units is 2.5 years as of December 31, 2016.

 

   

Occupancy and travel and entertainment expenses for the year ended December 31, 2016 increased $4.0 million, or 15.0%, to $30.9 million compared to the same period in 2015. This increase is primarily due to increased occupancy costs associated with our increased headcount and increased supplies, research and printing and travel and entertainment costs stemming from the increase in capital markets services revenues.

 

   

Other expenses, including costs for insurance, professional fees, depreciation and amortization, interest on our warehouse line of credit and other operating expenses, were $40.6 million in the year ended December 31, 2016, an increase of $9.4 million, or 30.2%, versus $31.2 million in the year ended December 31, 2015. This increase is primarily related to an increase in our interest expense on our warehouse lines of credit supporting our participation in the Freddie Mac Program business of $3.8 million, an increase of $3.5 million in other operating expenses, and an increase of $2.6 million in depreciation and amortization.

Operating income.    Our operating income in 2016 was $95.8 million, a decrease of $12.0 million from $107.8 million in 2015 attributable to the factors discussed above.

 

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Interest and other income, net.    Interest and other income, net in 2016 increased $1.5 million, or 4.6%, to $33.5 million from $32.0 million in 2015. This increase was primarily due to increased income from a higher production volume on loans originated in our participation in the Freddie Mac Program during 2016 as compared to 2015. The increase in transaction volume resulted in an increase in the valuation of servicing rights, which were partially offset by decreases in gains on sale of mortgage servicing rights from the sale of certain mortgage servicing rights that were part of a securitization pool and decreases in securitization compensation.

Interest expense.    The interest expense we incurred during the year ended December 31, 2016 totaled $42,000 compared to $47,000 of similar expenses incurred in the year ended December 31, 2015.

Net Income.    Our net income for the year ended December 31, 2016 was $77.2 million, a decrease of $6.8 million, or 8.1%, compared to $84.0 million for the same fiscal period in 2015. In addition to the factors affecting operating income, interest and other income, net and interest expense discussed above, other factors impacting net income included:

 

   

The increase in the payable under the tax receivable agreement of $1.0 million and the decrease of $2.1 million for the years ended December 31, 2016 and 2015, respectively, primarily reflects the change in the estimated tax benefits owed to HFF Holdings under the tax receivable agreement as we are obligated to pay HFF Holdings 85% of cash savings, if any, in U.S. federal, state and local income tax that we realize as a result of the increase in tax basis pursuant to our election under Section 754. Each year we update the tax rates used to measure the deferred tax assets which resulted in an increase in deferred tax assets of $1.2 million and a decrease of $2.6 million for 2016 and 2015, respectively, as such, 85% of these amounts impacted the amounts anticipated to be paid to HFF Holdings and therefore we increased the payable under the tax receivable agreement by $1.0 million in 2016 and decreased it by $2.1 million in 2015.

 

   

Income tax expense was approximately $51.0 million for the year ended December 31, 2016, a decrease of approximately $6.9 million over $57.9 million in the year ended December 31, 2015. This decrease is primarily due to the lower income before income taxes in 2016 as compared to 2015. During the year ended December 31, 2016, the Company recorded current income tax expense of $34.5 million and deferred income tax expense of approximately $16.5 million. During the year ended December 31, 2015, the Company recorded current income tax expense of $41.7 million and a deferred income tax expense of $16.2 million. For further detail relating to the Operating Partnerships’ tax basis step-up election under Section 754, refer to Note 13 to our consolidated financial statements.

Financial Condition

Total assets increased to $892.2 million at December 31, 2017 compared to $716.7 million at December 31, 2016 due primarily to:

 

   

An increase in mortgage notes receivable of $159.9 million to $450.8 million at December 31, 2017 from $290.9 million at December 31, 2016 due to increased principal on loans outstanding related to our participation in the Freddie Mac Program business at December 31, 2017 as compared to December 31, 2016.

 

   

An increase in cash and cash equivalents and restricted cash of $41.2.

 

   

An increase in intangible assets, net of $22.2 million to $58.8 million at December 31, 2017 from $36.6 million at December 31, 2016 and an increase in goodwill of $5.0 million.

Offsetting these increases was a reduction in deferred tax assets of $61.7 million primarily due to the effect of reduced statutory rates related to the 2017 Tax Act as well as the amortization of the Section 754 step-up in basis.

 

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Total liabilities increased to $605.7 million at December 31, 2017 compared to $480.1 million at December 31, 2016, due primarily to:

 

   

An increase in our warehouse lines of credit of $159.3 million due to increased principal on loans outstanding related to our participation in the Freddie Mac Program business at December 31, 2017 as compared to December 31, 2016.

 

   

An increase in accrued compensation and related taxes of $7.9 million due to increased accrued profit participation, accrued incentive compensation and accrued commissions of $4.1 million, $2.2 million and $1.4 million respectively.

 

   

An increase in other current liabilities of $6.5 million primarily due to a $6.2 million increase in client advances relating to the Freddie Mac Program business at December 31, 2017 as compared to December 31, 2016.

Offsetting these increases was reduction in the payable under the tax receivable agreement of $50.5 million primarily due to the impact of the reduction in statutory tax rates associated with the 2017 Tax Act as well as the payment of $11.2 million to HFF Holdings for the 2016 tax year.

Stockholders’ equity increased to $286.5 million at December 31, 2017 from $236.5 million at December 31, 2016 primarily due to the $95.0 million of net income earned during the year ended December 31, 2017 and the recording of stock based compensation of $20.7 million in 2017 which were partially offset by a dividend payment of $60.0 million and a payment of $5.9 million to purchase shares of Class A common stock in connection with the minimum employee statutory tax withholdings.

Cash Flows

Our historical cash flows are primarily related to the timing of receipt of transaction fees, the timing of payments under the tax receivable agreement and payment of commissions and bonuses to employees.

2017

Cash and cash equivalents and restricted cash increased $41.2 million in the year ended December 31, 2017. Net cash of $120.4 million was provided by operating activities, primarily resulting from net income and adjustments to reconcile net income of $117.5 million. Working capital added an additional $4.9 million of cash from operations which was partially offset by a $2.0 million reduction in cash use associated with noncurrent assets and liabilities. Cash used for investing activities included $6.6 million for property and equipment and $6.2 million for the acquisition of two businesses. Financing activities used $66.3 million of cash which was primarily due to a $60.0 million dividend payment that we made to holders of our Class A common stock on February 21, 2017. Additionally, $5.9 million was used to purchase shares of Class A common stock in connection with the minimum employee statutory tax withholdings.

2016

Cash and cash equivalents increased $1.7 million in the year ended December 31, 2016. Net cash of $79.3 million was provided by operating activities, primarily resulting from $77.2 million of net income and $2.6 million of proceeds from the sale of the cashiering portion of mortgage servicing rights on certain loans that were part of a securitization pool. These increases of cash were partially offset by a $10.8 million payment to HFF Holdings under the tax receivable agreement, a $7.4 million decrease in accrued compensation and related taxes, and a $4.8 million decrease in prepaid taxes, prepaid expenses and other current assets. Cash of $5.3 million was used for investing in property and equipment. Financing activities used $72.4 million of cash which was primarily due to a $68.4 million dividend payment that we made to holders of our Class A common stock on February 19, 2016. Additionally, $3.0 million was used to purchase shares of Class A common stock in connection with the minimum employee statutory tax withholdings.

 

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Liquidity and Capital Resources

Our current assets typically have consisted primarily of cash and cash equivalents and accounts receivable in relation to earned transaction fees. At December 31, 2017, our cash and cash equivalents of $272.8 million were invested or held at three financial institutions in a mix of money market funds and bank demand deposit accounts. Our current liabilities have typically consisted of accounts payable and accrued compensation. We regularly monitor our liquidity position, including cash levels, credit lines, interest and payments on debt, capital expenditures and matters relating to liquidity and to compliance with regulatory net capital requirements.

Over the twelve-month period ended December 31, 2017, we generated approximately $120.4 million of cash from operations. Our short-term liquidity needs are typically related to compensation expenses and other operating expenses such as occupancy, supplies, marketing, professional fees and travel and entertainment. For the year ended December 31, 2017, we incurred approximately $504.2 million in total operating expenses. A large portion of our operating expenses are variable, highly correlated to our revenue streams and dependent on the collection of transaction fees. During the year ended December 31, 2017, approximately 60.9% of our operating expenses were variable expenses. Our cash flow generated from operations historically has been sufficient to enable us to meet our working capital needs. However, if the economy deteriorates in the future we may be unable to generate enough cash flow from operations to meet our operating needs and therefore we could use all or substantially all of our existing cash reserves on hand to support our operations. As of February 20, 2018, our cash and cash equivalents were approximately $211.9 million. We currently believe that cash flows from operating activities and our existing cash balance will provide adequate liquidity and are sufficient to meet our working capital needs for the foreseeable future.

On January 26, 2018, our board of directors declared a special cash dividend of $1.75 per share of Class A common stock to stockholders of record on February 9, 2018. The aggregate dividend payment was paid on February 21, 2018 and totaled approximately $67.5 million based on the number of shares of Class A common stock then outstanding. Additionally, 79,387 restricted stock units (dividend equivalent units) were granted for those unvested and vested but not issued restricted stock units as of the record date of February 9, 2017. These dividend equivalent units follow the same vesting terms as the underlying restricted stock units.

On January 24, 2017, our board of directors declared a special cash dividend of $1.57 per share of Class A common stock to stockholders of record on February 9, 2017. The aggregate dividend payment was paid on February 21, 2017 and totaled approximately $60.0 million based on the number of shares of Class A common stock then outstanding. Additionally, 95,648 restricted stock units (dividend equivalent units) were granted for those unvested and vested but not issued restricted stock units as of the record date of February 9, 2017. These dividend equivalent units follow the same vesting terms as the underlying restricted stock units. We currently do not intend to pay any additional cash dividends on our Class A common stock. The declaration and payment of any future dividends will be at the sole discretion of our board of directors.

Our tax receivable agreement with HFF Holdings entered into in connection with our initial public offering provides for the payment by us to HFF Holdings of 85% of the amount of cash savings, if any, in U.S. federal, state and local income taxes that we actually realize as a result of the increases in tax basis and as a result of certain other tax benefits arising from our entering into the tax receivable agreement and making payments under that agreement. We have estimated that the payments that will be made to HFF Holdings will be $60.9 million, of which approximately $11.8 million is anticipated to be paid during 2018. Our liquidity needs related to our long term obligations are primarily related to our facility leases and capital lease obligations. Additionally, for the year ended December 31, 2017, we incurred approximately $16.2 million in occupancy expenses.

We are a party to an uncommitted $600 million financing arrangement with PNC, which can be increased to $800 million an unlimited number of times per year for a period of 30 calendar days and has a maximum capacity of $1.5 billion. We also have an uncommitted $150 million financing arrangement with Huntington that can be increased to $175 million three times in a one-year period for 45 calendar days and may be increased to

 

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$175 million from October 1, 2017 through February 15, 2018 to fund our Freddie Mac loan closings. Pursuant to these arrangements, PNC or Huntington funds the multifamily Freddie Mac loan closings in accordance with the Freddie Mac Program on a transaction-by-transaction basis, with each loan being separately collateralized by a loan and mortgage on a multifamily property that is ultimately purchased by Freddie Mac. The PNC and Huntington financing arrangements are only for the purpose of supporting our participation in the Freddie Mac Program and cannot be used for any other purpose. On October 2, 2017, HFF LP entered into an extended funding agreement with Freddie Mac whereby Freddie Mac can extend the required purchase date for each mortgage that has an Original Funding Date (as defined in the agreement) occurring within the fourth quarter of 2017, to February 15, 2018. In connection with the extended funding agreement with Freddie Mac, PNC agreed to increase its financing arrangement to $2.0 billion. The maximum capacity under the PNC arrangement will revert to $1.5 billion after the expiration of the extended funding agreement. As of December 31, 2017, we had outstanding borrowings of $450.3 million under the PNC/Huntington arrangements. Non-cash activity totaling $159.3 million increased these financing arrangements during the twelve-month period ended December 31, 2017. Although we believe that our current financing arrangements with PNC and Huntington are sufficient to meet our current needs in connection with our participation in the Freddie Mac Program, in the event we are not able to secure financing for our Freddie Mac loan closings, we will cease originating such Freddie Mac loans until we have available financing.

Critical Accounting Policies

We prepare our financial statements in accordance with U.S. generally accepted accounting principles. In applying many of these accounting principles, we need to make assumptions, estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses in our consolidated financial statements. We base our estimates and judgments on historical experience and other assumptions that we believe are reasonable under the circumstances. These assumptions, estimates and/or judgments, however, are often subjective and our actual results may change negatively based on changing circumstances or changes in our analyses. If actual amounts are ultimately different from our estimates, the revisions are included in our results of operations for the period in which the actual amounts become known. We believe the following critical accounting policies could potentially produce materially different results if we were to change underlying assumptions, estimates and/or judgments. See the notes to our consolidated financial statements for a summary of our significant accounting policies.

Business Combinations.    The Company accounts for acquired businesses using the acquisition method of accounting, which requires that the assets acquired and liabilities assumed be recorded at the date of acquisition at their respective estimated fair values. The cost to acquire a business is allocated to the underlying net assets of the acquired business based on estimates of their respective fair values. The purchase price allocation process requires management to make significant estimates and assumptions with respect to intangible assets. Although we believe the assumptions and estimates we have made are reasonable, they are based in part on historical experience and information obtained from the management of the acquired companies and are inherently uncertain. Examples of critical estimates in valuing certain of the intangible assets we have acquired or may acquire in the future include but are not limited to: future expected cash flows from customer relationships and discount rates. The fair value of the acquired intangible assets is considered a level 3 asset within the fair value hierarchy and is amortized over the expected life of the asset.

Goodwill.    Any excess of the purchase price over the estimated fair values of the net assets acquired is recorded as goodwill. Goodwill is required to be tested for impairment at least annually. The Company performs its annual impairment test as of October 1st or more frequently when indicators of impairment are present. The goodwill impairment test involves comparing the fair value of a reporting unit to its carrying value, including goodwill. A goodwill impairment loss is recognized for the amount that the carrying amount of a reporting unit, including goodwill, exceeds its fair value, limited to the total amount of goodwill allocated to that reporting unit. The Company uses a combination of a discounted cash flow model (“DCF model”) and a market approach to determine the current fair values of the reporting units. A number of significant assumptions and estimates are involved in the application of the DCF model to forecast operating cash flows, including capital market

 

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information and market share, sales volume and pricing, costs of services, working capital changes and discount rates. The fair value of goodwill is considered a level 3 asset within the fair value hierarchy.

Intangible Assets.    Intangible assets include mortgage servicing rights under agreements with third-party lenders, non-competition agreements and customer relationships. Servicing rights are recorded at the lower of cost or market. Mortgage servicing rights do not trade in an active, open market with readily available observable prices. Since there is no ready market value for the mortgage servicing rights, such as quoted market prices or prices based on sales or purchases of similar assets, we determine the fair value of the mortgage servicing rights by estimating the present value of future cash flows associated with servicing the loans. Management makes certain assumptions and judgments in estimating the fair value of servicing rights. The estimate is based on a number of assumptions, including the benefits of servicing (contractual servicing fees and interest on escrow and float balances), the cost of servicing, prepayment rates (including risk of default), an inflation rate, the expected life of the cash flows and the discount rate. Management estimates a market participant’s cost of servicing by analyzing the limited market activity and considering our own internal servicing costs. Management estimates the discount rate by considering the various risks involved in the future cash flows of the underlying loans which include the cancellation of servicing contracts, concentration in the life company portfolio and the incremental risk related to large loans. Management estimates the prepayment levels of the underlying mortgages by analyzing recent historical experience. Many of the commercial loans being serviced have financial penalties for prepayment or early payoff before the stated maturity date. As a result, we have consistently experienced a low level of loan runoff. The estimated value of the servicing rights is impacted by changes in these assumptions. As of December 31, 2017, the fair value and net book value of the servicing rights were $75.9 million and $58.5 million, respectively. The most sensitive assumptions in estimating the fair value of the mortgage servicing rights are the level of prepayments, discount rate and cost of servicing. If the assumed level of prepayments increased 107%, the discount rate increased 70% or if there is a 12% increase in the cost of servicing at the stratum level, the estimated fair value of the servicing rights may result in the recorded mortgage servicing rights being potentially impaired and would require management to measure the amount of the potential impairment charge. The effect of a variation in each of these assumptions on the estimated fair value of the servicing rights is calculated independently without changing any other assumption. Servicing rights are amortized in proportion to and over the period of estimated servicing income which results in an accelerated level of amortization. We evaluate intangible assets on an annual basis, or more frequently if circumstances so indicate, for potential impairment.

Income Taxes.    The Company accounts for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and for tax losses and tax credit carryforwards, if any. Deferred tax assets and liabilities are measured using tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates are recognized in income in the period of the tax rate change. In assessing the realizability of deferred tax assets, the Company considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized.

The 2017 Tax Act significantly revises the U.S. corporate income tax by, among other things, lowering the statutory corporate tax rate from 35% to 21%, eliminating certain deductions, imposing a mandatory one-time tax on accumulated earnings of foreign subsidiaries, introducing new tax regimes, and changing how foreign earnings are subject to U.S. tax. The 2017 Tax Act also enhanced and extended through 2026 the option to claim accelerated depreciation deductions on qualified property. We have not completed our determination of the accounting implications of the 2017 Tax Act on our tax accruals. However, we have reasonably estimated the effects of the 2017 Tax Act and recorded provisional amounts in our financial statements as of December 31, 2017. As we complete our analysis of the 2017 Tax Act, collect and prepare necessary data, and interpret any additional guidance issued by the U.S. Treasury Department, the IRS, and other standard-setting bodies, we may make adjustments to the provisional amounts. Those adjustments may materially impact our provision for income taxes in the period in which the adjustments are made.

 

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Our effective tax rate is sensitive to several factors including changes in the mix of our geographic profitability. We evaluate our estimated tax rate on a quarterly basis to reflect changes in: (i) our geographic mix of income, (ii) legislative actions on statutory tax rates and (iii) tax planning for jurisdictions affected by double taxation. We continually seek to develop and implement potential strategies and/or actions that would reduce our overall effective tax rate.

The net deferred tax asset of $50.9 million at December 31, 2017 is comprised mainly of a $57.8 million deferred tax asset related to the Section 754 election tax basis step up. The deferred tax asset related to the Section 754 election tax basis step up of $57.8 million represents annual pre-tax deductions on the Section 754 basis step up and past payments under the tax receivable agreement of approximately $38.4 million in 2018 then increasing to $45.7 million in 2021 and then decreasing over the eight years to approximately $0.1 by 2029. In order to realize the anticipated pre-tax benefit of approximately $38.4 million in 2018, the Company needs to generate approximately $369 million in revenue, assuming a constant cost structure. In the event that the Company cannot realize the annual pre-tax benefit each year, the shortfall becomes a net operating loss that can be carried forward indefinitely to offset future taxable income. If it is more likely than not that the Company would not be able to generate a sufficient level of taxable income through the carryforward period, a valuation allowance would be recorded as a charge to income tax expense and a proportional reduction in the payable under the tax receivable agreement which would be recorded as income in the consolidated statements of comprehensive income. The trend in revenue growth over the next few years and through the amortization and carryforward periods is a key factor in assessing the realizability of the deferred tax assets

Leases.    The Company leases all of its facilities under operating lease agreements. These lease agreements typically contain tenant improvement allowances. The Company records tenant improvement allowances as leasehold improvement assets, included in property and equipment, net in the Consolidated Balance Sheets, and a related deferred rent liability and amortizes them on a straight-line basis over the shorter of the term of the lease or useful life of the asset as additional depreciation expense and a reduction to rent expense, respectively. Lease agreements sometimes contain rent escalation clauses or rent holidays, which are recognized on a straight-line basis over the life of the lease in accordance with ASC 840, Leases (ASC 840). Lease terms generally range from three to eleven years. An analysis is performed on each equipment lease to determine whether it should be classified as a capital or an operating lease according to ASC 840.

Firm and Office Profit Participation Plans and Executive Bonus Plan.    The Company’s Firm and Office Profit Participation Plans and Executive Bonus Plan provide for payments in cash and share-based awards if certain performance targets are achieved during the year. The expense recorded for these plans is estimated during the year based on actual results at each interim reporting date and an estimate of future results for the remainder of the year. The plans allow for payments to be made in both cash and share-based awards, the composition of which is determined in the first calendar quarter of the subsequent year. Cash and share-based awards issued under these plans are subject to vesting conditions over the subsequent year, such that the total expense measured for these plans is recorded over the period from the beginning of the performance year through the vesting date. Based on an accounting policy election, the expense associated with the share-based component of the estimated incentive payout is recognized before the grant date of the stock due to the fact that the terms of the profit participation plans have been approved by the Company’s board of directors, the employees of the Company understand the requirements to earn the award, the number of shares is not determined before the grant date and, finally, if the performance metrics are not met during the performance year, the award is not earned and therefore forfeited. Prior to the grant date, the share-based component expense is recorded as incentive compensation within personnel expenses in the Company’s consolidated statements of comprehensive income. Following the award, if any, of the related incentive payout, the stock component expense is reclassified as stock compensation costs within personnel expenses. See Note 2 to the Company’s consolidated financial statements for further information regarding the Company’s accounting policies relating to its Firm and Office Profit Participation Plans and Executive Bonus Plan.

Mortgage Notes Receivable.    Under the Freddie Mac Program, the Company originates mortgages based on commitments from Freddie Mac, and then sells the loans to Freddie Mac approximately one month following

 

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the loan origination. The Company recognizes interest income on the accrual basis during this holding period based on the contract interest rate in the loan that will be purchased by Freddie Mac.

The Company records mortgage loans held for sale at period end at fair value. The fair value of the mortgage notes receivable is considered a Level 2 asset in the fair value hierarchy as it is based on prices observable in the market for similar loans.

Certain Information Concerning Off-Balance Sheet Arrangements

We do not currently invest in any off-balance sheet vehicles that provide liquidity, capital resources, market or credit risk support, or engage in any leasing activities that expose us to any liability that is not reflected in our consolidated financial statements.

Contractual and Other Cash Obligations

The following table summarizes our contractual and other cash obligations at December 31, 2017 (dollars in thousands):

 

            Payments Due by Period  
     Total      Less Than
1 Year
     1-3
Years
     4-5
Years
     More Than
5 Years
 

Warehouse line of credit

   $ 450,255      $ 450,255      $      $      $  

Operating lease obligations

     59,712        11,159        20,819        15,187        12,547  

Capital lease obligations

     405        269        136                

Employment agreements (1)

     569        569                       
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total contractual obligations

   $ 510,941      $ 462,252      $ 20,955      $ 15,187      $ 12,547  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)

From time to time we enter into employment agreements with our capital markets advisors. Some of these agreements may include payments to be made to the individual at a specific time, if certain conditions have been met. The Company accrues for these payments over the life of the agreement.

In connection with the Reorganization Transactions, HFF LP and HFF Securities made an election under Section 754 for 2007 and kept that election in effect for each taxable year in which an exchange of Operating Partnership units for shares of Class A common stock occurred. The initial sale as a result of the Company’s initial public offering increased the tax basis of the assets owned by HFF LP and HFF Securities to their fair market value. This increase in tax basis allows us to reduce the amount of future tax payments to the extent that we have future taxable income. We are obligated, however, pursuant to our Tax Receivable Agreement with HFF Holdings, to pay to HFF Holdings, 85% of the amount of cash savings, if any, in U.S. federal, state and local income tax that we actually realize as a result of these increases in tax basis and as a result of certain other tax benefits arising from entering into the tax receivable agreement and making payments under that agreement. While the actual amount and timing of payments under the tax receivable agreement will depend upon a number of factors, including the amount and timing of taxable income generated in the future, changes in future tax rates, the value of individual assets, the portion of our payments under the tax receivable agreement constituting imputed interest and increases in the tax basis of our assets resulting in payments to HFF Holdings, we have estimated the payments that will be made to HFF Holdings will be $60.9 million, of which $11.8 million is anticipated to be paid in 2018, and have recorded this obligation to HFF Holdings as a liability on the consolidated balance sheets.

Seasonality

Our capital markets services revenue has historically been seasonal, which can affect an investor’s ability to compare our financial condition and results of operation on a quarter-by-quarter basis. This seasonality has

 

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caused our revenue, operating income, net income and cash flows from operating activities to be lower in the first half of the year and higher in the second half of the year. The typical concentration of earnings and cash flows in the last half of the year has historically been due to an industry-wide focus of clients to complete transactions towards the end of the calendar year. However, we have seen disruptions, write-offs and credit losses in the global and domestic capital markets, the liquidity issues facing all global capital markets, and in particular the U.S. commercial real estate markets, this historical pattern of seasonality may or may not continue.

Effect of Inflation and/or Deflation

Inflation or deflation, or both, could significantly affect our compensation costs, particularly those not directly tied to our capital markets advisors’ compensation, due to factors such as availability of capital and/or increased costs of capital. The rise of inflation could also significantly and adversely affect certain expenses, such as debt service costs, information technology and occupancy costs. To the extent that inflation and/or deflation results in rising interest rates and has other effects upon the commercial real estate markets in which we operate and, to a lesser extent, the securities markets, it may affect our financial position and results of operations by reducing the demand for commercial real estate and related services, which could have a material adverse effect on our financial condition. See “Risk Factors — General Economic Conditions and Commercial Real Estate Market Conditions.”

Recent Accounting Pronouncements

For information regarding Recent Accounting Pronouncements, see Note 2 of the Notes to Consolidated Financial Statements, included in Item 8 of this Annual Report on Form 10-K.”

 

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

Due to the nature of our business and the manner in which we conduct our operations, in particular the fact that our financial instruments that are exposed to concentrations of credit risk consist primarily of short-term cash deposits and investments, we believe we do not face any material interest rate risk, equity price risk or other market risk.

Foreign Currency Exchange Rate Risk

We may be subject to exposures to changes in foreign currency exchange rates. Our risk management objective is to reduce our exposure to the effects of changes in exchange rates and we may manage our exposure to changes in foreign currency exchange rates by entering into foreign currency forward contracts. We did not engage in foreign currency hedging transactions during the three-year period ended December 31, 2017.

 

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Item 8. Financial Statements and Supplementary Data

 

     Page  

HFF, Inc.

  

Management’s Report on Effectiveness of Internal Control Over Financial Reporting

     50  

Report of Independent Registered Public Accounting Firm on Consolidated Financial Statements

     51  

Report of Independent Registered Public Accounting Firm on Effectiveness of Internal Control over Financial Reporting

     52  

Consolidated Balance Sheets as of December 31, 2017 and 2016

     53  

Consolidated Statements of Comprehensive Income for the years ended December 31, 2017, 2016 and 2015

     54  

Consolidated Statements of Stockholders’ Equity for the years ended December  31, 2017, 2016 and 2015

     55  

Consolidated Statements of Cash Flows for the years ended December 31, 2017, 2016 and 2015

     56  

Notes to Consolidated Financial Statements

     57  

 

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Management’s Report on Effectiveness of Internal Control Over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended). The Company’s system of internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

Because of the inherent limitations, a system of internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management assessed the effectiveness of HFF, Inc.’s internal control over financial reporting as of December 31, 2017, in relation to criteria for effective internal control over financial reporting as described in “Internal Control — Integrated Framework,” (2013 framework) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management concluded that, as of December 31, 2017, its system of internal control over financial reporting is properly designed and operating effectively to achieve the criteria of the “Internal Control — Integrated Framework.” Ernst & Young LLP, our independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report and has issued an attestation report on HFF, Inc.’s internal control over financial reporting.

 

Dated: February 28, 2018     /s/ Mark D. Gibson
    Mark D. Gibson
    Chief Executive Officer
Dated: February 28, 2018     /s/ Gregory R. Conley
    Gregory R. Conley
    Chief Financial Officer

 

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Report of Independent Registered Public Accounting Firm

To the Stockholders and the Board of Directors of HFF, Inc.

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of HFF, Inc. (the Company) as of December 31, 2017 and 2016, and the related consolidated statements of comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2017, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2017, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 28, 2018 expressed an unqualified opinion thereon.

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures include examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/     Ernst & Young LLP

We have served as the Company’s auditor since 2006.

Pittsburgh, Pennsylvania

February 28, 2018

 

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Report of Independent Registered Public Accounting Firm

To the Stockholders and the Board of Directors of HFF, Inc.

Opinion on Internal Control over Financial Reporting

We have audited HFF, Inc.’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, HFF, Inc. (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2017 and 2016, the related consolidated statements of comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2017, and the related notes and our report dated February 28, 2018 expressed an unqualified opinion thereon.

Basis for Opinion

The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Effectiveness of Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audit in accordance with the standards of the PCAOB and in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.

Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

Definition and Limitations of Internal Control Over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/    Ernst & Young LLP

Pittsburgh, Pennsylvania

February 28, 2018

 

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HFF, Inc.

Consolidated Balance Sheets

 

     December 31  
     2017     2016  
     (Dollars in thousands)  
ASSETS  

Current assets:

    

Cash and cash equivalents

   $ 272,801     $ 235,582  

Restricted cash

     4,001        

Accounts receivable

     2,272       2,124  

Receivable from affiliate

            

Mortgage notes receivable

     450,821       290,933  

Prepaid taxes

     978       1,118  

Prepaid expenses and other current assets

     16,575       12,971  
  

 

 

   

 

 

 

Total current assets

     747,448       542,728  

Property and equipment, net

     17,897       15,837  

Deferred tax asset

     50,874       112,557  

Goodwill

     8,688       3,712  

Intangible assets, net

     58,837       36,614  

Other noncurrent assets

     8,461       5,211  
  

 

 

   

 

 

 

Total assets

   $ 892,205     $ 716,659  
  

 

 

   

 

 

 
LIABILITIES AND STOCKHOLDERS’ EQUITY  

Current liabilities:

    

Current portion of long-term debt

   $ 269     $ 448  

Warehouse line of credit

     450,255       290,980  

Accrued compensation and related taxes

     52,574       44,685  

Accounts payable

     3,527       2,065  

Current portion of payable under the tax receivable agreement

     11,838       11,315  

Other current liabilities

     25,338       18,803  
  

 

 

   

 

 

 

Total current liabilities

     543,801       368,296  

Deferred rent credit

     12,700       11,485  

Payable under the tax receivable agreement

     49,101       100,077  

Long-term debt, less current portion

     136       259  
  

 

 

   

 

 

 

Total liabilities

     605,738       480,117  

Stockholders’ equity:

    

Class A common stock, par value $0.01 per share, 175,000,000 shares authorized; 38,742,698 and 38,463,448 shares issued, respectively; and 38,579,544 and 38,091,123 outstanding, respectively

     387       385  

Treasury stock, 163,154 and 372,325 shares at cost, respectively

     (4,971     (11,477

Additional paid-in-capital

     144,304       132,513  

Accumulated other comprehensive income

     171        

Retained earnings

     146,576       115,121  
  

 

 

   

 

 

 

Total equity

     286,467       236,542  
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 892,205     $ 716,659  
  

 

 

   

 

 

 

See accompanying notes to the consolidated financial statements.

 

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HFF, Inc.

Consolidated Statements of Comprehensive Income

 

     Years Ending December 31,  
     2017     2016     2015  
     (Dollars in thousands, except share data)  

Revenues

      

Capital markets services revenue

   $ 586,346     $ 498,590     $ 487,941  

Interest on mortgage notes receivable

     19,114       15,198       11,205  

Other

     4,018       3,638       2,844  
  

 

 

   

 

 

   

 

 

 
     609,478       517,426       501,990  

Expenses

      

Cost of services

     342,208       291,290       280,674  

Personnel

     62,174       51,171       47,732  

Occupancy

     16,165       14,133       12,236  

Travel and entertainment

     19,507       16,786       14,644  

Supplies, research, and printing

     8,934       7,700       7,769  

Insurance

     2,475       2,242       2,472  

Professional fees

     7,077       5,493       5,787  

Depreciation and amortization

     17,001       11,834       9,194  

Interest on warehouse line of credit

     14,583       9,385       5,540  

Other operating

     14,026       11,619       8,169  
  

 

 

   

 

 

   

 

 

 
     504,150       421,653       394,217  
  

 

 

   

 

 

   

 

 

 

Operating income

     105,328       95,773       107,773  

Interest and other income, net

     57,209       33,525       32,043  

Interest expense

     (21     (42     (47

Decrease (increase) in payable under the tax receivable agreement

     39,212       (1,025     2,143  
  

 

 

   

 

 

   

 

 

 

Income before taxes

     201,728       128,231       141,912  

Income tax expense

     106,768       51,036       57,949  
  

 

 

   

 

 

   

 

 

 

Net income

   $ 94,960     $ 77,195     $ 83,963  
  

 

 

   

 

 

   

 

 

 

Other comprehensive income:

      

Foreign currency translation adjustments

     171              
  

 

 

   

 

 

   

 

 

 

Comprehensive income

   $ 95,131     $ 77,195     $ 83,963  
  

 

 

   

 

 

   

 

 

 

Earnings per share — Basic and Diluted

      

Earnings per share available to HFF, Inc. common stockholders — Basic

   $ 2.46     $ 2.02     $ 2.21  
  

 

 

   

 

 

   

 

 

 

Earnings per share available to HFF, Inc. common stockholders —Diluted

   $ 2.39     $ 1.99     $ 2.18  
  

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding — Basic

     38,662,118       38,245,682       37,975,997  
  

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding — Diluted

     39,673,152       38,843,156       38,449,212  
  

 

 

   

 

 

   

 

 

 

See accompanying notes to the consolidated financial statements.

 

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HFF, Inc.

Consolidated Statements of Stockholders’ Equity

 

    Common Stock     Treasury Stock     Additional
Paid in
Capital
    Accumulated
Other
Comprehensive
Income
    Retained
Earnings
    Total  

(Dollars in thousands)

  Shares     Amount     Shares     Amount          

Stockholders’ equity, December 31, 2014

    36,677,981     $ 381       447,382     $ (9,042   $ 101,148     $     $ 93,958     $ 186,445  

Issuance of Class A common stock, net

    244,649       2       (18,645     40       187                   229  

Repurchase of Class A common stock

    (68,318           68,318       (2,376                       (2,376

Incremental tax adjustment from stock-based award activities

                            465                   465  

Stock compensation and other, net

                            13,599                   13,599  

Dividends paid

                            1,817             (69,638     (67,821

Net income

                                        83,963       83,963  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Stockholders’ equity, December 31, 2015

    37,854,312     $ 383       497,055     $ (11,378   $ 117,216     $     $ 108,283     $ 214,504  

Issuance of Class A common stock, net

    348,892       2       (236,811     2,880       (2,789                 93  

Repurchase of Class A common stock

    (112,081           112,081       (2,979                       (2,979

Incremental tax adjustment from stock-based award activities

                            (581                 (581

Stock compensation and other, net

                            16,672                   16,672  

Dividends paid

                            1,995             (70,357     (68,362

Net income

                                        77,195       77,195  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Stockholders’ equity, December 31, 2016

    38,091,123     $ 385       372,325     $ (11,477   $ 132,513     $     $ 115,121     $ 236,542  

Foreign currency translation income

                                  171             171  

Issuance of Class A common stock, net

    681,970       2       (405,088     12,439       (12,441                  

Repurchase of Class A common stock

    (193,549           195,917       (5,933                       (5,933

Stock compensation and other, net

                            21,301             (557     20,744  

Dividends paid

                            2,931             (62,948     (60,017

Net income

                                        94,960       94,960  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Stockholders’ equity, December 31, 2017

    38,579,544     $ 387       163,154     $ (4,971   $ 144,304     $ 171     $ 146,576     $ 286,467  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to the consolidated financial statements.

 

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HFF, Inc.

Consolidated Statements of Cash Flows

 

     2017     2016     2015  
     (Dollars in thousands)  

Operating activities

  

Net income

   $ 94,960     $ 77,195     $ 83,963  

Adjustments to reconcile net income to net cash provided by operating activities:

      

Stock based compensation

     17,385       12,310       8,579  

Incremental tax adjustment from share-based award activities

           581       (465

Deferred income taxes

     61,683       16,534       16,173  

Payable under the tax receivable agreement

     (39,212     1,025       (2,143

Depreciation and amortization:

      

Property and equipment

     4,307       3,268       2,522  

Intangibles

     12,694       8,565       6,678  

Gain on sale and initial recording of mortgage servicing rights

     (29,935     (16,033     (16,761

Mortgage service rights assumed

     (4,425     (4,420     (4,090

Proceeds from sale of mortgage servicing rights

           2,612       6,096  

Increase (decrease) in cash from changes in:

      

Accounts receivable

     765       1,879       (2,541

Payable to/ (receivable from) affiliate

           4       (2

Payable under the tax receivable agreement

     (11,241     (10,824     (10,822

Mortgage notes receivable

     (159,275     27,638       (133,490

Net borrowings on warehouse line of credit

     159,275       (27,638     133,490  

Prepaid taxes, prepaid expenses and other current assets

     (3,434     (4,791     (4,526

Other noncurrent assets

     (3,250     (3,044     (1,152

Accrued compensation and related taxes

     11,248       (7,431     10,163  

Accounts payable

     1,455       (53     31  

Other accrued liabilities

     6,135       328       (17,115

Other long-term liabilities

     1,215       1,611       3,102  
  

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

     120,350       79,316       77,690  

Investing activities

      

Purchases of property and equipment

     (6,579     (5,254     (5,897

Purchase of businesses, net of cash acquired

     (6,198            
  

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

     (12,777     (5,254     (5,897

Financing activities

      

Payments on long-term debt

     (302     (555     (439

Proceeds from stock options exercised

           93       229  

Incremental tax adjustment from share-based award activities

           (581     465  

Treasury stock

     (5,933     (2,979     (2,376

Dividends paid

     (60,017     (68,362     (67,821
  

 

 

   

 

 

   

 

 

 

Net cash used in financing activities

     (66,252     (72,384     (69,942
  

 

 

   

 

 

   

 

 

 

Effect of exchange rate changes on cash and cash equivalents

     (101            
  

 

 

   

 

 

   

 

 

 

Net increase in cash and cash equivalents

     41,220       1,678       1,851  

Cash and cash equivalents, beginning of period

     235,582       233,904       232,053  
  

 

 

   

 

 

   

 

 

 

Cash and cash equivalents and restricted cash, end of period

   $ 276,802     $ 235,582     $ 233,904  
  

 

 

   

 

 

   

 

 

 

Supplemental disclosure of cash flow information

      

Cash paid for income taxes

   $ 41,889     $ 34,601     $ 43,311  
  

 

 

   

 

 

   

 

 

 

Cash paid for interest

   $ 14,614     $ 9,258     $ 5,328  
  

 

 

   

 

 

   

 

 

 

Supplemental disclosure of non-cash financing activities

      

Property acquired under capital leases

   $ 154     $ 249     $ 801  
  

 

 

   

 

 

   

 

 

 

Dividends on unissued restricted stock units

   $ 2,931     $ 1,995     $ 1,817  
  

 

 

   

 

 

   

 

 

 

See accompanying notes to the consolidated financial statements.

 

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Table of Contents

HFF, Inc.

Notes to Consolidated Financial Statements

 

1.

Organization and Basis of Presentation

Organization

HFF, Inc., a Delaware corporation (the “Company”), through its wholly-owned subsidiaries, Holliday Fenoglio Fowler, L.P., a Texas limited partnership (“HFF LP”), and HFF Securities L.P., a Delaware limited partnership and registered broker-dealer (“HFF Securities” and together with HFF LP, the “Operating Partnerships”), HFF Real Estate Limited and HFF Securities Limited, in the United Kingdom, is a commercial real estate financial intermediary providing commercial real estate and capital markets services including debt placement, investment advisory, equity placements, investment banking and advisory services, loan sales and loan sale advisory services, commercial loan servicing, and capital markets advice and maintains offices in 25 cities in the United States and effective January 17, 2017, one office in London, United Kingdom. The Company’s operations are impacted by the availability of equity and debt as well as credit and liquidity in the domestic and global capital markets especially in the commercial real estate sector. Significant disruptions or changes in domestic and global capital market flows, as well as credit and liquidity issues in the global and domestic capital markets, regardless of their duration, could adversely affect the supply and demand for capital from investors for commercial real estate investments which could have a significant impact on all of the Company’s capital market services revenues.

Initial Public Offering and Reorganization

The Company completed its initial public offering (“IPO”) in the first quarter of 2007 and the Company’s Class A Common Stock began trading on the New York Stock Exchange under the symbol “HF.” The proceeds of the initial public offering, including the exercise of the underwriter’s option to purchase additional shares, were used to purchase from HFF Holdings LLC, a Delaware limited liability company (“HFF Holdings”), all of the shares of Holliday GP Corp. (“Holliday GP”) and purchase from HFF Holdings partnership units of the Operating Partnerships (including partnership units in the Operating Partnerships held by Holliday GP). HFF Holdings used a portion of its proceeds to repay all outstanding indebtedness under HFF LP’s credit agreement. Accordingly, the Company did not retain any of the proceeds from the initial public offering.

In addition to cash received for its sale of all of the shares of Holliday GP and approximately 45% of partnership units of each of the Operating Partnerships (including partnership units in the Operating Partnerships held by Holliday GP), HFF Holdings also received, through the issuance of one share of HFF, Inc.’s Class B common stock to HFF Holdings, an exchange right that permitted, subject to certain restrictions, HFF Holdings to exchange interests in the Operating Partnerships for shares of (i) the Company’s Class A common stock (the “Exchange Right”) and (ii) rights under a tax receivable agreement between the Company and HFF Holdings (the “TRA”). See Notes 13 and 17 for further discussion of the tax receivable agreement and the exchange right held by HFF Holdings.

As a result of the reorganization into a holding company structure in connection with the IPO, the Company became a holding company through a series of transactions pursuant to a sale and purchase agreement. As a result of the IPO and reorganization, the Company’s sole assets were partnership interests in Operating Partnerships (that are held through its wholly-owned subsidiary HFF Partnership Holdings, LLC, a Delaware limited liability company (“Partnership Holdings”)) and all of the shares of Holliday GP, the sole general partner of each of the Operating Partnerships. The transactions that occurred in connection with the IPO and reorganization are referred to as the “Reorganization Transactions.”

The Reorganization Transactions were treated, for financial reporting purposes, as a reorganization of entities under common control. As of August 31, 2012, HFF Holdings had utilized its Exchange Right to exchange all of its remaining interests in the Operating Partnerships and therefore the Company, through its wholly-owned subsidiaries, became and continues to be the sole equity holder of the Operating Partnerships.

 

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Table of Contents

HFF, Inc.

Notes to Consolidated Financial Statements — (Continued)

 

Basis of Presentation

The accompanying consolidated financial statements of the Company include the accounts of HFF LP, HFF Securities, HFF Real Estate Limited and HFF Securities Limited, as well as the Company’s additional wholly-owned subsidiaries, Holliday GP and Partnership Holdings. All significant intercompany accounts and transactions have been eliminated.

 

2.

Summary of Significant Accounting Policies

Consolidation

The accompanying consolidated financial statements of HFF, Inc. have been prepared by the Company’s management in accordance with generally accepted accounting principles in the United States for financial information and applicable rules and regulations promulgated under the Securities Exchange act of 1934, as amended. The consolidated financial statements of the Company include the accounts of its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.

Concentrations of Credit Risk

The Company’s financial instruments that are exposed to concentrations of credit risk consist primarily of cash. The Company places its cash with financial institutions in amounts which at times exceed the FDIC insurance limit. The Company has not experienced any losses in such accounts and believes it is not exposed to any credit risk on cash other than as identified herein.

Cash and Cash Equivalents

Cash and cash equivalents include cash on hand and in bank accounts and short-term investments with original maturities of three months or less. At December 31, 2017, our cash and cash equivalents were invested or held in a mix of money market funds and bank demand deposit accounts at two financial institutions.

Restricted Cash

Restricted cash represents good faith deposits from borrowers that are held between the time we enter into a rate-lock commitment with the borrower and Freddie Mac’s purchase of the loan. The Company records a corresponding liability for such good faith deposits from borrowers within other current liabilities within the consolidated balance sheets.

Revenue Recognition

Capital markets services revenues consist of origination fees, investment advisory fees, loan sales fees, placement fees and servicing fees. Origination fees are earned for the placement of debt, equity or structured financing for real estate transactions. Investment advisory and loan sales fees are earned for brokering sales of real estate and/or loans. Placement fees are earned by HFF Securities for discretionary and nondiscretionary equity capital raises and other investment banking services. These fees are negotiated between the Company and its clients, generally on a case-by-case basis and are recognized and generally collected at the closing and the funding of the transaction, unless the fees are not fixed or determinable or collection of the fee is not reasonably assured, in which case the fee is recognized as collected. The Company’s fee agreements do not include terms or conditions that require the Company to perform any service or fulfill any obligation once the transaction closes. Servicing fees are compensation for providing any or all of the following: collection, remittance, recordkeeping, reporting and other services for either lenders or borrowers on mortgages placed with third-party lenders. Servicing fees are recognized when cash is collected as these fees are contingent upon the borrower making its payments on the loan.

 

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Table of Contents

HFF, Inc.

Notes to Consolidated Financial Statements — (Continued)

 

Certain of the Company’s fee agreements provide for reimbursement of transaction-related costs which the Company recognizes as revenue. Reimbursements received from clients for out-of-pocket expenses are characterized as revenue in the statement of income rather than as a reduction of expenses incurred. Since the Company is the primary obligor, has supplier discretion, and bears the credit risk for such expenses, the Company records reimbursement revenue for such out-of-pocket expenses. Reimbursement revenue is recognized when billed if collectibility is reasonably assured. Reimbursement revenue is classified as other revenue in the consolidated statements of comprehensive income.

Mortgage Notes Receivable

The Company is qualified with the Federal Home Loan Mortgage Corporation (“Freddie Mac”) as a Freddie Mac Multifamily Approved Seller/Servicer for Conventional and Senior Housing Loan provider (“Freddie Mac Program”). Under the Freddie Mac Program, the Company originates mortgages based on commitments from Freddie Mac, and then sells the loans to Freddie Mac approximately one month following the loan origination. The Company recognizes interest income on the accrual basis during this holding period based on the contract interest rate in the loan that will be purchased by Freddie Mac (see Note 8).

The Company records mortgage loans held for sale at period end at fair value. The fair value of the mortgage notes receivable is considered a Level 2 asset in the fair value hierarchy as it is based on prices observable in the market for similar loans.

Freddie Mac requires HFF LP to meet minimum net worth and liquid assets requirements and to comply with certain other standards. As of December 31, 2017, HFF LP met Freddie Mac’s minimum net worth and liquid assets requirements.

Advertising

Costs associated with advertising are expensed as incurred. Advertising expense was $0.9 million, $1.0 million and $0.9 million for the years ended December 31, 2017, 2016 and 2015, respectively. These amounts are included in other operating expenses in the accompanying consolidated statements of comprehensive income.

Property and Equipment

Property and equipment are recorded at cost. The Company depreciates furniture, office equipment and computer equipment on the straight-line method over three to seven years. Software costs are depreciated using the straight-line method over three years, while capital leases and leasehold improvements are depreciated using the straight-line method over the shorter of the term of the lease or useful life of the asset.

Depreciation expense was $4.3 million, $3.3 million and $2.5 million for the years ended December 31, 2017, 2016 and 2015, respectively.

Expenditures for routine maintenance and repairs are charged to expense as incurred. Renewals and betterments which substantially extend the useful life of an asset are capitalized.

Leases

The Company leases all of its facilities under operating lease agreements. These lease agreements typically contain tenant improvement allowances. The Company records tenant improvement allowances as a leasehold

 

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Table of Contents

HFF, Inc.

Notes to Consolidated Financial Statements — (Continued)

 

improvement asset, included in property and equipment, net in the consolidated balance sheet, and a related deferred rent liability and amortizes them on a straight-line basis over the shorter of the term of the lease or useful life of the asset as additional depreciation expense and a reduction to rent expense, respectively. Lease agreements sometimes contain rent escalation clauses or rent holidays, which are recognized on a straight-line basis over the life of the lease in accordance with ASC 840, Leases (ASC 840). Office lease terms generally range from five to ten years. An analysis is performed on all equipment leases to determine whether they should be classified as a capital or an operating lease according to ASC 840.

Computer Software Costs

Certain costs related to the development or purchases of internal-use software are capitalized. Internal computer software costs that are incurred in the preliminary project stage are expensed as incurred. Direct consulting costs as well as payroll and related costs, which are incurred during the development stage of a project are capitalized and amortized using the straight-line method over estimated useful lives of three years when placed into production.

Business Combinations

The Company accounts for acquired businesses using the acquisition method of accounting, which requires that the assets acquired and liabilities assumed be recorded at the date of acquisition at their respective estimated fair values. The cost to acquire a business is allocated to the underlying net assets of the acquired business based on estimates of their respective fair values. The purchase price allocation process requires management to make significant estimates and assumptions with respect to intangible assets. Acquired intangible assets are amortized over the expected life of the asset. Any excess of the purchase price over the estimated fair values of the net assets acquired is recorded as goodwill.

Goodwill

Goodwill is required to be tested for impairment at least annually. The Company performs its annual impairment test as of October 1st or more frequently when indicators of impairment are present. The goodwill impairment test involves comparing the fair value of a reporting unit to its carrying value, including goodwill. A goodwill impairment loss is recognized for the amount that the carrying amount of a reporting unit, including goodwill, exceeds its fair value, limited to the total amount of goodwill allocated to that reporting unit. The Company uses a combination of a discounted cash flow model (“DCF model”) and a market approach to determine the current fair values of the reporting units. A number of significant assumptions and estimates are involved in the application of the DCF model to forecast operating cash flows, including markets and market share, sales volume and pricing, costs of services, working capital changes and discount rates.

Intangible Assets

Intangible assets include mortgage servicing rights under agreements with third-party lenders, non-competition agreements and customer relationships.

Servicing rights are capitalized for servicing assumed on loans originated and sold to Freddie Mac with servicing retained based on an allocation of the carrying amount of the loan and the servicing right in proportion to the relative fair values at the date of sale. Servicing rights are recorded at the lower of cost or market.

Mortgage servicing rights do not trade in an active, open market and therefore, do not have readily available observable prices. Since there is no ready market value for the mortgage servicing rights, such as quoted market

 

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HFF, Inc.

Notes to Consolidated Financial Statements — (Continued)

 

prices or prices based on sales or purchases of similar assets, the Company determines the fair value of the mortgage servicing rights by estimating the net present value of future cash flows associated with the servicing of the loans. Management makes certain assumptions and judgments in estimating the fair value of servicing rights. The estimate is based on a number of assumptions, including the benefits of servicing (contractual servicing fees and interest on escrow and float balances), the cost of servicing, prepayment rates (including risk of default), an inflation rate, the expected life of the cash flows and the discount rate. The cost of servicing, prepayment rates and discount rates are the most sensitive factors affecting the estimated fair value of the servicing rights. Management estimates a market participant’s cost of servicing by analyzing the limited market activity and considering the Company’s own internal servicing costs. Management estimates the discount rate by considering the various risks involved in the future cash flows of the underlying loans which include the cancellation of servicing contracts and the incremental risk related to large loans. Management estimates the prepayment levels of the underlying mortgages by analyzing recent historical experience. Many of the commercial loans being serviced have financial penalties for prepayment or early payoff before the stated maturity date. As a result, the Company has consistently experienced a low level of loan runoff. The estimated value of the servicing rights is impacted by changes in these assumptions.

The Company applies the provisions of ASC 860, Transfers and Servicing (“ASC 860”) to such services. ASC 860 requires an entity to recognize a servicing asset or servicing liability at fair value each time it undertakes an obligation to service a financial asset by entering into a servicing contract, regardless of whether explicit consideration is exchanged. The guidance also permits a company to choose to either subsequently measure servicing rights at fair value and to report changes in fair value in earnings, or to retain the amortization method whereby servicing rights are recorded at the lower of cost or fair value and are amortized over their expected life. The Company utilizes the amortization method.

The Company evaluates intangible assets on an annual basis, or more frequently if circumstances so indicate, for potential impairment. Indicators of impairment monitored by management include a decline in the level of serviced loans as well as other negative economic conditions.

Prepaid Compensation Under Employment Agreements

The Company entered into employment agreements with certain employees whereby sign-up bonuses and incentive compensation payments were made during 2017, 2016 and 2015. In most cases, the sign-up bonuses and the incentive compensation are to be repaid to the Company upon voluntary termination by the employee or termination by cause, as defined by the Company, prior to the termination of the employment agreement. The total cost of the employment agreements is being amortized using the straight-line method over the term of the agreements and is included in cost of services on the accompanying consolidated statements of comprehensive income. As of December 31, 2017 and 2016, there was a total of approximately $12.8 million and $6.8 million of unamortized costs, respectively.

Capital Markets Advisor Draws

As part of the Company’s overall compensation program, the Company offers a new capital markets advisor a draw arrangement which generally lasts until such time as a capital markets advisor’s pipeline of business is sufficient to allow the capital markets advisor to earn sustainable commissions. This program is intended to provide the capital markets advisor with a minimal amount of cash flow to allow adequate time for the capital markets advisor to develop business relationships. Similar to traditional salaries, the capital markets advisor draws are paid irrespective of the actual fees generated by the capital markets advisor. At times these capital markets advisor draws represent the only form of compensation received by the capital markets advisor. It is not the Company’s policy to seek collection of unearned capital markets advisor draws under

 

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HFF, Inc.

Notes to Consolidated Financial Statements — (Continued)

 

this arrangement. Capital markets advisors are also entitled to earn a commission on closed revenue transactions. Commissions are calculated as the commission that would have been earned by the broker under one of the Company’s commission programs, less any amount previously paid to the capital markets advisor in the form of a draw. As a result, the Company has concluded that capital markets advisor draws are economically equivalent to commissions paid and, accordingly, charges them to commissions as incurred. These amounts are included in cost of services on the accompanying consolidated statements of comprehensive income.

Earnings Per Share

The Company computes earnings per share in accordance with ASC 260, Earnings Per Share. Basic earnings per share is computed by dividing income available to Class A common stockholders by the weighted average of common shares outstanding for the period. Diluted earnings per share reflects the assumed conversion of all dilutive securities (see Note 15).

Firm and Office Profit Participation Plans and Executive Bonus Plan

The Company’s Firm and Office Profit Participation Plans and effective January 1, 2015, an Executive Bonus Plan (the “Plans”) provide for payments in cash and share-based awards if certain performance metrics are achieved during the year. The expense recorded for these Plans is estimated during the year based on actual results at each interim reporting date and an estimate of future results for the remainder of the year. The Plans allow for payments to be made in both cash and share-based awards, the composition of which is determined in the first calendar quarter of the subsequent year. Cash and share-based awards issued under these Plans are subject to vesting conditions over the subsequent year, such that the total expense measured for these Plans is recorded over the period from the beginning of the performance year through the vesting date. Based on an accounting policy election and consistent with ASC 718, Compensation – Stock Compensation, the expense associated with the estimated share-based component of the estimated incentive payout is recognized before the grant date of the stock due to the fact that the terms of the Plans have been approved by the Company’s board of directors, the employees of the Company understand the requirements to earn the award, the number of shares is not determined before the grant date and, finally, if the performance metrics are not met during the performance year, the award is not earned and therefore forfeited. Prior to the grant date, the share-based component expense is recorded as incentive compensation within personnel expenses in the Company’s consolidated statements of comprehensive income. Following the award, if any, of the related incentive payout, the share-based component of the accrued incentive compensation is reclassified as additional paid-in-capital upon the granting of the awards on the Company’s consolidated balance sheets.

Prior to January 1, 2015, the Company’s Office and Firm Profit Participation Plans allowed for payment to be made in both cash and share-based awards, and the composition of such payment was determined in the first calendar quarter of the subsequent year. A portion of the cash and share-based awards issued under these Office and Firm Profit Participation Plans are subject to time-based vesting conditions over the subsequent twelve months of the grant date, such that the total expense measured for these Plans is recorded over the period from the beginning of the performance year through the vesting date, or 26 months. In addition, prior to January 1, 2015, awards made under the Executive Bonus Plans were historically settled as a cash payment made in the first calendar quarter of the subsequent year, with the entire award recognized as expense in the performance year.

Effective January 1, 2015, the Company amended the Plans, which will now provide for an overall increase in the allocation of share-based awards. The cash portion of the awards will not be subject to time-based vesting conditions and will be expensed during the performance year. The share-based portion of the awards is subject to a three-year time-based vesting schedule beginning on the first anniversary of the grant (which is made in the first calendar quarter of the subsequent year). As a result, the total expense for the share-based portion of the

 

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Notes to Consolidated Financial Statements — (Continued)

 

awards is recorded over the period from the beginning of the performance year through the vesting date, or 50 months. Therefore, under the new design of the Plans, the expense recognized during the performance year will be less than the expense that would have been recognized in the performance year under the previous Plan design. The Company expects that difference will be recognized as an increase in expense over the subsequent three years, irrespective of the Company’s financial performance in the future periods.

Stock Based Compensation

ASC 718, Compensation — Stock Compensation (ASC 718), requires the measurement and recognition of compensation expense for all stock-based payment awards made to employees and directors, including employee stock options and other forms of equity compensation based on estimated fair values. The Company estimates the grant-date fair value of stock options using the Black-Scholes option-pricing model. The fair value of the restricted stock unit awards is calculated as the market value of the Company’s Class A common stock on the date of grant. The Company’s awards are subject to graded or cliff vesting. Compensation expense is adjusted for forfeitures as they occur and is recognized on a straight-line basis over the requisite service period of the award.

Income Taxes

HFF, Inc. and Holliday GP are corporations, and the Operating Partnerships are limited partnerships. The Operating Partnerships are subject to state and local income taxes. Income and expenses of the Operating Partnerships are passed through and reported on the corporate income tax returns of HFF, Inc. and Holliday GP. Income taxes shown on the Company’s consolidated statements of comprehensive income reflect federal income taxes of the corporation and business and corporate income taxes in various jurisdictions including the UK Subsidiaries.

The Company accounts for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and for tax losses and tax credit carryforwards, if any. Deferred tax assets and liabilities are measured using tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates will be recognized in income in the period of the tax rate change. In assessing the realizability of deferred tax assets, the Company considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized.

The recently enacted U.S. tax reform legislation commonly referred to as the U.S. Tax Cuts and Jobs Act of 2017 (the “2017 Tax Act”) was signed into law on December 22, 2017. The 2017 Tax Act significantly revises the U.S. corporate income tax by, among other things, lowering the statutory corporate tax rate from 35% to 21%, eliminating certain deductions, imposing a mandatory one-time tax on accumulated earnings of foreign subsidiaries, introducing new tax regimes, and changing how foreign earnings are subject to U.S. tax. The 2017 Tax Act also enhanced and extended through 2026 the option to claim accelerated depreciation deductions on qualified property. We have not completed our determination of the accounting implications of the 2017 Tax Act on our tax accruals. However, we have reasonably estimated the effects of the 2017 Tax Act and recorded provisional amounts in our financial statements as of December 31, 2017. As we complete our analysis of the 2017 Tax Act, collect and prepare necessary data, and interpret any additional guidance issued by the U.S. Treasury Department, the IRS, and other standard-setting bodies, we may make adjustments to the provisional amounts. Those adjustments may materially impact our provision for income taxes in the period in which the adjustments are made.

 

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Notes to Consolidated Financial Statements — (Continued)

 

Cost of Services

The Company considers personnel expenses directly attributable to providing services to its clients, such as salaries, commissions and transaction bonuses to capital markets advisors and analysts, and certain purchased services to be directly attributable to the generation of capital markets services revenue and has classified these expenses as cost of services in the consolidated statements of comprehensive income.

Segment Reporting

The Company operates in one reportable segment, the commercial real estate financial intermediary segment and offers debt placement, investment advisory, loan sales, loan servicing, equity placement and investment banking services through its 26 offices. The results of each office have been aggregated for segment reporting purposes as they have similar economic characteristics and provide similar services to a similar class of customer.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Treasury Stock

The Company records common stock purchased for treasury at cost. At the date of subsequent reissue, the treasury stock account is reduced by the cost of such stock on the first-in, first-out basis.

Recent Accounting Pronouncements

In March 2016, the FASB issued changes to the accounting for equity compensation. This update simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. This update also permits an entity to make an election to either estimate the number of awards that are expected to vest or account for forfeitures as they occur. This update was effective for the Company beginning in fiscal year 2017 and the Company made an election to change its accounting for forfeitures from the previously-required estimation method to recognizing forfeitures when they occur. The Company recognized $0.6 million as a reduction in retained earnings on January 1, 2017 as a result of eliminating the estimated forfeiture rate on unvested RSUs.

In December 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-19 – “Technical Corrections and Improvements”, which covers a wide range of Topics in the Accounting Standards Codification (“ASC”). The amendments in the guidance represent changes to clarify, correct errors, or make minor improvements to the ASC, making it easier to understand and apply by eliminating inconsistencies and providing clarifications. The amendments generally fall into one of the following categories: amendments related to differences between original guidance and the ASC, guidance clarification and reference corrections, simplification, or minor improvements. Most of the amendments in this update do not require transition guidance and are effective upon issuance of this ASU.

 

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HFF, Inc.

Notes to Consolidated Financial Statements — (Continued)

 

In February 2016, the FASB issued new guidance on the accounting for leases. This new guidance will require that a lessee recognize assets and liabilities on the balance sheet for all leases with a lease term of more than twelve months, with the result being the recognition of a right of use asset and a lease liability. The new lease accounting requirements are effective for the Company’s 2019 fiscal year with a modified retrospective transition approach required, with early adoption permitted. The Company is currently evaluating the impact of the new guidance on its consolidated financial statements.

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers,” which is required to be adopted by the Company as of January 1, 2018. This ASU supersedes the revenue recognition requirements in FASB ASC Topic 605, “Revenue Recognition,” and most industry-specific guidance. The standard implements a five-step model for determining when and how revenue is recognized along with expanded disclosure requirements. Under the model, an entity will be required to recognize revenue to depict the transfer of goods or services to a customer at an amount reflecting the consideration it expects to receive in exchange for those goods or services. The new standard also permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method) or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (modified retrospective method).

The Company adopted the new standard on January 1, 2018, using the modified retrospective approach. The Company has completed its evaluation of the impact of adopting the revenue recognition standard and has concluded that the timing of revenue recognition for certain equity placement services will be accelerated. However, the adoption of this accounting guidance will not have a material effect on the consolidated financial statements. The Company also expects to include additional revenue recognition disclosures within the notes to the financial statements in accordance with the new requirements.

In November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash.” This ASU requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. As a result, amounts restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. This ASU is effective for fiscal years beginning after December 15, 2017, and interim periods within those years, with early adoption permitted. As permitted by the ASU, the Company early adopted ASU 2016-18 in the fourth quarter of 2017. The adoption of ASU 2016-18 had no impact on the Consolidated Statements of Cash Flows for the years ended December 31, 2016 and 2015.

In January 2017, the FASB issued ASU 2017-01 “Business Combinations (Topic 805): Clarifying the Definition of a Business,” which clarifies the definition of a business to assist entities with evaluating whether transactions should be accounted for as acquisitions or disposals of assets or businesses. The standard introduces a screen for determining when assets acquired are not a business and clarifies that a business must include, at a minimum, an input and a substantive process that contribute to an output to be considered a business. This standard is effective for fiscal years beginning after December 15, 2017, including interim periods within that reporting period. The Company does not expect the adoption of ASU 2017-01 will a material impact on the consolidated financial statements and related disclosures.

In January 2017, FASB issued ASU No. 2017-04, “Intangibles — Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.” This ASU eliminates Step 2 from the goodwill impairment test. This ASU also eliminates the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. This ASU is effective for fiscal years beginning after December 15, 2019, and interim periods within those years, with early adoption permitted. The Company adopted ASU 2017-04 in the current year and there was no impact on the consolidated financial statements and related disclosures.

 

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Notes to Consolidated Financial Statements — (Continued)

 

May 2017, the FASB issued ASU 2017-09, “Stock Compensation (Topic 718): Scope of Modification Accounting”. ASU 2017-09 clarifies when changes to the terms or conditions of a share-based payment award must be accounted for as modifications. The guidance is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017 with early adoption permitted. The Company is currently evaluating the impact that this guidance will have on its consolidated financial statements.

 

3.

Stock Compensation

ASC 718 requires the measurement and recognition of compensation expense for all stock-based payment awards made to employees and directors including employee stock options and other forms of equity compensation based on estimated fair values. The Company estimates the grant-date fair value of stock options using the Black-Scholes option-pricing model. For stock options, the Company uses the simplified method to determine the expected term of the option. Expected volatility used to value stock options is based on the Company’s historical volatility. The Company has not granted any stock options since 2010. The fair value of the restricted stock unit awards is calculated as the market value of the Company’s Class A common stock on the date of grant. The Company’s awards are subject to graded or cliff vesting. Compensation expense is adjusted for forfeitures as they occur and is recognized on a straight-line basis over the requisite service period of the award. A summary of the cost of the awards granted during the years ended December 31, 2017 and 2016 is provided below.

Equity Incentive Plan

Prior to the effective date of the initial public offering, the stockholder of HFF, Inc. and the Board of Directors adopted the HFF, Inc. 2006 Omnibus Incentive Compensation Plan (the “2006 Plan”). The 2006 Plan authorized the grant of deferred stock, restricted stock, stock options, stock appreciation rights, stock units, stock purchase rights and cash-based awards. Upon the effective date of the registration statement, grants were awarded under the 2006 Plan to certain employees and non-employee members of the board of directors. The 2006 Plan imposed limits on the awards that may be made to any individual during a calendar year. The number of shares available for awards under the terms of the 2006 Plan was 3,500,000 (subject to stock splits, stock dividends and similar transactions). On May 26, 2016, the stockholders of HFF, Inc. adopted the 2016 Equity Incentive Plan (the “2016 Equity Plan”). The 2016 Equity Plan replaces the 2006 Plan and reserves for 3,859,524 (including 109,524 shares not previously awarded under the 2006 Plan) shares for issuance of awards. The 2016 Equity Plan authorizes the grant of options, SARs, restricted stock, restricted stock units and other stock-based awards. For a full copy of the 2016 Equity Plan, see Annex B to the Proxy Statement filed with the SEC on April 29, 2016.

The stock compensation cost that has been charged against income for the years ended December 31, 2017, 2016 and 2015 was $17.4 million, $12.3 million and $8.6 million, respectively, which is recorded in “Personnel” expenses in the consolidated statements of comprehensive income. At December 31, 2017, there was approximately $32.6 million of unrecognized compensation cost related to share based awards.

The fair value of stock options is estimated on the grant date using a Black-Scholes option-pricing model. The following table presents the weighted average assumptions for stock options still outstanding as of December 31, 2017:

 

Dividend yield

     0.0

Expected volatility

     72.8

Risk-free interest rate

     2.2

Expected life (in years)

     6.0  

 

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Notes to Consolidated Financial Statements — (Continued)

 

The following table presents options outstanding for the years ended December 31, 2017, 2016 and 2015 and their related weighted average exercise price, weighted average remaining contractual term and intrinsic value:

 

     Options      Weighted
Average
Exercise
Price
     Weighted
Average
Remaining
Contractual
Term
     Aggregate
Intrinsic
Value
(in ‘000’s)
 

Balance at December 31, 2014

     51,586      $ 8.92        4.0 years      $ 1,393  

Granted

                           

Exercised

     (26,594      8.61        2.5 years        875  

Forfeited or expired

                           
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance at December 31, 2015

     24,992      $ 9.25        3.5 years      $ 777  

Granted

                           

Exercised

     (5,338      17.41        0.2 years        159  

Forfeited or expired

                           
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance at December 31, 2016

     19,654      $ 7.04        3.1 years      $ 595  

Granted

                           

Exercised

                           

Forfeited or expired

                           
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance at December 31, 2017

     19,654      $ 7.04        2.1 years      $ 956  
  

 

 

    

 

 

    

 

 

    

 

 

 

No options were granted, vested, forfeited or expired during the years ended December 31, 2017, 2016 and 2015. During the year ended December 31, 2017, no options were exercised. Future exercise of options will be settled through the re-issuance of treasury shares.

A summary of restricted stock units (“RSU”) activity and related information during the period was as follows:

 

     RSU’s with no
vesting period
     RSU’s with graded
or cliff vesting
period
     Total  

Balance at January 1, 2015

     143,187        900,318        1,043,505  

Granted

     9,108        461,597        470,705  

Dividend on unissued RSU’s

     6,748        42,635        49,383  

Converted to common stock

     (2,793      (215,262      (218,055

Forfeited or expired

            (49,689      (49,689
  

 

 

    

 

 

    

 

 

 

Balance at December 31, 2015

     156,250        1,139,599        1,295,849  

Granted

     12,372        1,060,434        1,072,806  

Dividend on unissued RSU’s

     11,576        70,960        82,536  

Converted to common stock

     (2,035      (341,519      (343,554

Forfeited or expired

            (26,745      (26,745
  

 

 

    

 

 

    

 

 

 

Balance at December 31, 2016

     178,163        1,902,729        2,080,892  

Granted

     14,598        818,282        832,880  

Dividend on unissued RSU’s

     9,046        86,602        95,648  

Converted to common stock

     (2,927      (598,078      (601,005

Forfeited or expired

            (18,867      (18,867
  

 

 

    

 

 

    

 

 

 

Balance at December 31, 2017

     198,880        2,190,668        2,389,548  
  

 

 

    

 

 

    

 

 

 

 

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HFF, Inc.

Notes to Consolidated Financial Statements — (Continued)

 

As of December 31, 2017, there were 2,389,548 RSU’s outstanding. The fair value of vested RSU’s was $10.2 million and $5.9 million at December 31, 2017 and December 31, 2016, respectively. The RSU exercises will be settled through either the issuance of new shares of Class A common stock or treasury shares.

The weighted average remaining contractual term of the unvested restricted stock units is 2.0 years as of December 31, 2017.

On February 27, 2018, the board of directors for the Company granted 339,723 restricted stock units with a fair value of $15.9 million. A portion of the grant will vest over a three-year period with one-third vesting on each of the first, second and third anniversary of the grant and the remainder will vest over a five-year period with 20% vesting increments starting on the first anniversary of the grant. Additionally, on February 27, 2018, the board of directors for the Company granted 393,761 restricted stock units with a fair value of $18.5 million in connection with the 2017 Office and Firm Profit Participation Plans and Executive Bonus Plan which vest over a three-year period with one-third vesting on each of the first, second and third anniversary of the grant.

 

4.

Property and Equipment

Property and equipment consist of the following (in thousands):

 

     December 31  
     2017      2016  

Furniture and equipment

   $ 8,192      $ 7,667  

Computer equipment

     2,139        2,145  

Capitalized software costs

     2,567        2,043  

Leasehold improvements

     19,536        15,813  
  

 

 

    

 

 

 

Subtotal

     32,434        27,668  

Less accumulated depreciation and amortization

     (14,537      (11,831
  

 

 

    

 

 

 
   $ 17,897      $ 15,837  
  

 

 

    

 

 

 

At December 31, 2017 and 2016, the Company has recorded capital leased office equipment within furniture and equipment of $1.7 million and $1.9 million, respectively, including accumulated amortization of $1.3 million and $1.2 million, respectively, which is included within depreciation and amortization expense on the accompanying consolidated statements of comprehensive income. See Note 7 for discussion of the related capital lease obligations.

 

5.

Business Combinations, Goodwill and Intangible Assets

During the first quarter of 2017, the Company completed two acquisitions for approximately $6.2 million, net of cash received. The acquisitions of businesses in New York and the United Kingdom provide capital advisory and investment banking services to the commercial real estate market. The fair value of consideration transferred was allocated to the tangible and intangible assets acquired and liabilities assumed based on their estimated fair values at the acquisition date, with the remaining unallocated amount recognized as goodwill. Goodwill, of which, approximately $1.8 million is deductible for tax purposes, represents the expected synergies and the Company’s ability to control the assembled workforces of the acquired businesses.

 

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Notes to Consolidated Financial Statements — (Continued)

 

The Company’s goodwill as of and for the year ended December 31, 2017 and 2016 are summarized as follows (in thousands):

 

Balance at December 31, 2016

   $ 3,712  

Additions through acquisitions

     4,716  

Foreign currency translation

     260  
  

 

 

 

Balance at December 31, 2017

   $ 8,688  
  

 

 

 

The Company performs goodwill impairment tests annually during the fourth quarter, and also performs interim goodwill impairment tests if it is determined that it is more likely than not that the fair value of a reporting unit is less than the carrying amount. The Company elected to early adopt ASU 2017-04, Intangibles — Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment and proceeded directly to perform a quantitative goodwill impairment test as of October 1, 2017. The results of the annual impairment review concluded that no impairment existed as the fair value of our reporting units was in excess of their carrying value.

The Company’s intangible assets are summarized as follows (in thousands):

 

     December 31, 2017      December 31, 2016  
     Gross
Carrying
Amount
     Accumulated
Amortization
    Net Book
Value
     Gross
Carrying
Amount
     Accumulated
Amortization
    Net Book
Value
 

Mortgage servicing rights

   $ 92,856      $ (34,373   $ 58,483      $ 64,648      $ (28,034   $ 36,614  

Other

     959        (605     354                      
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total intangible assets

   $ 93,815      $ (34,978   $ 58,837      $ 64,648      $ (28,034   $ 36,614  
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

The Company’s intangible assets consist of mortgage servicing rights, non-competition agreements and customer relationships. The non-competition agreements and customer relationships intangible assets were assigned a five- and one-year useful life, respectively, and relate to the acquisitions completed during the first quarter of 2017.

As of December 31, 2017, 2016 and 2015, the Company serviced $69.8 billion, $58.0 billion and $48.7 billion, respectively, of commercial loans. The Company earned $29.1 million, $23.2 million and $20.0 million in servicing fees and interest on float and escrow balances for the years ended December 31, 2017, 2016 and 2015, respectively. These revenues are recorded as capital markets services revenues in the consolidated statements of comprehensive income.

The total commercial loan servicing portfolio includes loans for which there is no corresponding mortgage servicing right recorded on the balance sheet, as these servicing rights were assumed prior to January 1, 2007 and involved no initial consideration paid by the Company. The Company has recorded mortgage servicing rights of $58.5 million and $36.6 million on $68.8 billion and $56.5 billion, respectively, of the total loans serviced as of December 31, 2017 and 2016.

The Company stratifies its servicing portfolio based on the type of loan, including Freddie Mac, commercial mortgage backed securities (CMBS), life company loans and limited-service life company loans.

 

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Notes to Consolidated Financial Statements — (Continued)

 

Changes in the carrying value of mortgage servicing rights for the years ended December 31, 2017 and 2016 (in thousands):

 

Category

   12/31/16      Capitalized      Amortized     Sold / Transferred     12/31/17  

Freddie Mac

   $ 16,234      $ 29,546      $ (5,312   $     $ 40,468  

CMBS

     16,247        1,169        (3,902           13,514  

Life company

     3,567        2,791        (2,525           3,833  

Life company — limited

     566        465        (363           668  
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total

   $ 36,614      $ 33,971      $ (12,102   $     $ 58,483  
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Category

   12/31/15      Capitalized      Amortized     Sold / Transferred     12/31/16  

Freddie Mac

   $ 7,074      $ 14,480      $ (2,257   $ (3,063   $ 16,234  

CMBS

     16,768        1,059        (3,997     2,417       16,247  

Life company

     2,729        2,849        (2,011           3,567  

Life company — limited

     351        515        (300           566  
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total

   $ 26,922      $ 18,903      $ (8,565   $ (646   $ 36,614  
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Amounts capitalized represent mortgage servicing rights retained upon the sale of originated loans to Freddie Mac and mortgage servicing rights acquired without the exchange of initial consideration. The Company recorded mortgage servicing rights retained upon the sale of originated loans to Freddie Mac of $29.5 million and $14.5 million on $6.6 billion and $4.4 billion of loans, respectively, during the years ended December 31, 2017 and 2016, respectively. The Company recorded mortgage servicing rights acquired without the exchange of initial consideration on the CMBS and Life company tranches of $4.4 million and $4.4 million on $12.4 billion and $10.7 billion of loans, respectively, during the years ended December 31, 2017 and 2016. These amounts are recorded in interest and other income, net in the consolidated statements of comprehensive income. During each of 2017 and 2016, certain Freddie Mac loans were securitized and during 2016 the Company sold the cashiering portion of these Freddie Mac mortgage servicing rights. While the Company transferred the risks and rewards of ownership of the cashiering portion of the relevant mortgage servicing rights, the Company continues to perform limited servicing activities on these securitized loans. Therefore, the remaining servicing rights were transferred to the CMBS servicing tranche. The net result of these transactions was the Company recording a gain for the year ended December 31, 2016 of $2.0 million, within interest and other income, net in the consolidated statements of comprehensive income. The Company also received securitization compensation in relation to securitization of certain Freddie Mac mortgage servicing rights in the years ended December 31, 2017 and 2016 of $15.5 million and $5.5 million, respectively. The securitization compensation is recorded within interest and other income, net in the consolidated statements of comprehensive income.

Amortization expense related to intangible assets was $12.7 million, $8.6 million, and $6.7 million for the years ended December 31, 2017, 2016 and 2015, respectively, and is reported in depreciation and amortization in the consolidated statements of comprehensive income.

Estimated amortization expense for the next five years is as follows (in thousands):

 

2018

   $ 12,819  

2019

     10,384  

2020

     8,366  

2021

     7,129  

2022

     6,380  

 

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HFF, Inc.

Notes to Consolidated Financial Statements — (Continued)

 

The weighted-average remaining life of the mortgage servicing rights intangible asset was 6.0 and 6.5 years at December 31, 2017 and 2016, respectively.

 

6.

Fair Value Measurement

ASC Topic 820, Fair Value Measurement (ASC 820) establishes a valuation hierarchy for disclosure of the inputs to valuation used to measure fair value. This hierarchy prioritizes the inputs into the following three levels: Level 1 inputs which are quoted market prices in active markets for identical assets or liabilities; Level 2 inputs which are observable market-based inputs or unobservable inputs corroborated by market data for the asset or liability; and Level 3 inputs which are unobservable inputs based on our own assumptions that are not corroborated by market data. A financial asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.

In the normal course of business, the Company enters into contractual commitments to originate 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. To mitigate the effect of the interest rate risk inherent in providing rate lock commitments to borrowers, the Company enters into a sale commitment with Freddie Mac simultaneously with the rate lock commitment with the borrower. The terms of the contract with Freddie Mac and the rate lock with the borrower are matched in substantially all respects to eliminate interest rate risk. Both the rate lock commitments to borrowers and the forward sale contracts to buyers are undesignated derivatives with level 2 inputs and, accordingly, are marked to fair value through earnings. The impact on our financial position and earnings resulting from loan commitments is not significant. The Company elected the fair value option for all mortgage notes receivable originated after January 1, 2016 to eliminate the impact of the variability in interest rate movements on the value of the mortgage notes receivable.

The following table sets forth the Company’s financial assets that were accounted for at fair value on a recurring basis by level within the fair value hierarchy as of December 31, 2017 and 2016 (in thousands):

 

            December 31, 2017
Fair Value Measurements Using:
 
     Carrying
Value
     Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

Recurring fair value measurements

           

Mortgage notes receivable

   $ 450,821      $      $ 450,821         
  

 

 

    

 

 

    

 

 

    

 

 

 

Total recurring fair value measurements

   $ 450,821      $      $ 450,821         
  

 

 

    

 

 

    

 

 

    

 

 

 
            December 31, 2016
Fair Value Measurements Using:
 
     Carrying
Value
     Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

Recurring fair value measurements

           

Mortgage notes receivable

   $ 290,933      $      $ 290,933      $  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total recurring fair value measurements

   $ 290,933      $      $ 290,933      $  
  

 

 

    

 

 

    

 

 

    

 

 

 

The valuation of mortgage notes receivable is calculated based on already locked in interest rates. These assets are classified as Level 2 in the fair value hierarchy as all inputs are reasonable observable.

 

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HFF, Inc.

Notes to Consolidated Financial Statements — (Continued)

 

In accordance with GAAP, from time to time, the Company measures mortgage servicing rights at fair value on a nonrecurring basis. The mortgage serving rights are recorded at fair value upon initial recording and were not re-measured during 2017 because the Company continued to utilize the amortization method under ASC 860 and the fair value of the mortgage serving rights exceeds the carrying value at December 31, 2017. Adjustments are only recorded when the discounted cash flows derived from the valuation model are less than the carrying value of the asset. As such, mortgage servicing rights are subject to measurement at fair value on a nonrecurring basis.

The following tables sets forth the Company’s financial assets that were accounted for at fair value on a nonrecurring basis by level within the fair value hierarchy as of December 31, 2017 and 2016 (in thousands):

 

            December 31, 2017
Fair Value Measurements Using:
 
     Carrying
Value
     Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

Nonrecurring fair value measurements

           

Mortgage servicing rights

   $ 58,483                    $ 75,899  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total nonrecurring fair value measurements

   $ 58,483      $             $ 75,899  
  

 

 

    

 

 

    

 

 

    

 

 

 
            December 31, 2016
Fair Value Measurements Using:
 
     Carrying
Value
     Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

Nonrecurring fair value measurements

           

Mortgage servicing rights

   $ 36,614      $      $      $ 49,970  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total nonrecurring fair value measurements

   $ 36,614      $      $      $ 49,970  
  

 

 

    

 

 

    

 

 

    

 

 

 

Mortgage servicing rights do not trade in an active, open market with readily available observable prices. Since there is no ready market value for the mortgage servicing rights, such as quoted market prices or prices based on sales or purchases of similar assets, the Company determines the fair value of the mortgage servicing rights by estimating the present value of future cash flows associated with servicing the loans. Management makes certain assumptions and judgments in estimating the fair value of servicing rights. These assumptions include the benefits of servicing (contractual servicing fees and interest on escrow and float balances), the cost of servicing, prepayment rates (including risk of default), an inflation rate, the expected life of the cash flows and the discount rate.

The significant assumptions utilized to value servicing rights as of December 31, 2017 and 2016 are as follows:

 

     As of December 31,
     2017    2016

Expected life of cash flows

   3 years to 10 years    3 years to 11 years

Discount rate (1)

   10% to 16%    10% to 16

Prepayment rate

   0% to 8%    0% to 8%

Inflation rate

   2%    2%

Cost of service per loan

   $1,920 to $4,780    $1,920 to $4,997

 

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