VEL Velocity Financial

Christopher Oltmann Chief Accounting Officer and Director of Investor Relations
Christopher Farrar Chief Executive Officer
Mark Szczepaniak Chief Financial Officer
Stephen DeLaney JMP Securities
Stephen Laws Raymond James & Associates
Arren Cyganovich Citigroup Inc.
Donald Fandetti Wells Fargo & Company
Call transcript

Good afternoon and welcome to the Velocity Financial Incorporated Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mr. Chris Oltmann, Chief Accounting Officer. Please go ahead.

Christopher Oltmann

Thank you, Melanie. Hello, everyone, and thank you for joining us today for the discussion of Velocity Financial's second quarter 2021 results.

Joining me today are Chris Farrar, Velocity's President and Chief Executive Officer; and Mark Szczepaniak, Velocity's Chief Financial Officer. Earlier this afternoon, we released our second quarter 2021 press release and the accompanying earnings presentation, which are available on our Investor Relations' website. I'd like to remind everybody that today's call may include forward-looking statements, which are uncertain and outside of the company's control, and actual results may differ materially.

For a discussion of some of the risks and other factors that could affect results, please see the risk factors and other cautionary statements made in our communications with shareholders, including the risk factors disclosed in our filings with the Securities and Exchange Commission. Also note, the content of this call contains time-sensitive information that is accurate only as of today, and we do not undertake any duty to update forward-looking statements. We may also refer to certain non-GAAP measures on this call.

For reconciliations of these non-GAAP measures, you should refer to the earnings materials on our Investor Relations website. And finally, today's call is being recorded and will be available on the company's website later today. I will now turn the call over to Chris Farrar for some opening remarks.

Christopher Farrar

Thanks, Chris, and I'd like to welcome everyone to our second quarter management call. Obviously, we're very pleased with the outstanding quarter and results that were just released, experienced favorable trends and new originations, delinquencies, NPL resolutions, net interest margin and EPS. We see the improving fundamentals in the economy translating to better performance in our portfolio as well as increasing demand for new financing. tailwinds are very helpful to the business and our team is well positioned to capitalize on this favorable environment, specifically within our market niche.

Our special servicing team had another very strong quarter of recoveries as we continue to resolve delinquent loans profitably. Gains we recognized were impressive, and we saw a dramatic increase in realized NPL interest from these efforts. Residential real estate markets remain strong and we're seeing a healthy recovery in our segment of the commercial real estate market as well. Investor demand for our type of real estate is real and growing. Market conditions have helped us resolve NPLs and I want to congratulate our special servicing team on another great quarter. With respect to financing, we recently added another warehouse lending relationship and just launched our second securitization of the year earlier today. Capital markets continue to search for yield and we're seeing robust demand for securitized products.

As some of our older deals season, in the future, we plan to collapse them and take advantage of these lower rates. From an equity perspective, later in the presentation, we'll provide some new insights into how we think about the value of our business and introduce a new non-GAAP measure demonstrating the economic value of our equity.

Our goal there is to impart a simple understanding of the real value embedded in our platform. Team is very proud of the business we built and the results we've delivered. We plan to take full advantage of the great opportunities that lie ahead. And we appreciate everyone who supports us in pursuing those goals. That concludes my prepared remarks. And with that, I'll turn over to the presentation materials and start the presentation on Page 3 of the PDF. Very strong net income, core EPS of $0.25 a share, up 25% sequentially over the $0.20 that we reported in Q1. Biggest driver there was the pickup in net interest income from curing nonperforming assets. And you can see that translated directly into our NIM. NIM up 73 bps to 4.83%. These things are lumpy. And it's difficult for us to forecast and predict when delinquent loans are going to cure when somebody is going to reinstate or pay off.

So we expect going forward you'll see some volatility in NIM there. We always expect to collect that, that past due amount. We just don't know the exact timing and when that's actually going to fall. And then, all those earnings obviously translate into a nice pickup in book value.

On the loan production side, very healthy quarter, little over $250 million in originations, up 10% sequentially.

We also saw an improvement in the nonperforming loans that was a decrease of 153 pips quarter over quarter.

So, we're seeing nice trends there, continuing to see those delinquent assets get resolved.

As we've mentioned before, it did takes time, but definitely headed in the right direction.

In terms of the NPL and REO resolutions, again, another really strong quarter.

I think one of the strongest we've had, 103.9% of UPB in terms of gains above the contractual principal and interest.

So again, still making money off of delinquent assets, which obviously is very unique. From a financing and capital perspective, we did complete our 2021 securitization earlier in the year with a weighted average rate of 1.73%. Obviously, those, those costs of funds are very helpful to driving strong ROEs and good margins. Also, earlier in the quarter, we are very excited to see that we were added to the Russell 2000 and 3000 indices. That was a nice little boost for us. And then, subsequent to the - in the end of the quarter, we added the 5th warehouse line that I had mentioned earlier in our call.

So we've got a very broad base of good partners that will help us grow and fund future growth. Page 4, I'm just going to walk you through core income quickly and where value sits. Core income of $8.5 million excludes, obviously, the $1 million loan loss provision that we released, part of our CECL reserve process. Included in GAAP net income was almost $7 million of realized contractual interest, default interest in prepayment fee, 59% increase from the first quarter.

So again, very strong performance there on the resolutions. And then, nice pickup in book value per share.

So ended the quarter nicely there. Majority of the pickup here in just kind of portfolio earnings come [Technical Difficulty] all of the assets.

So that kind of wraps up my 2 slides. And I'll turn it over to Mark to take you through the next several slides. Mark?

Mark Szczepaniak

Thanks, Chris. Good afternoon and good evening, everybody. On Page 5 of the deck, really shows how the loan production momentum has continued to build going from $179 million in Q4 to $233 million, to over $256 million for Q2.

So 10% quarter over quarter from Q1 to - Q2 increase in our production volume. And that's driven by both an increase in our long-term product, that was up about 4% quarter-over-quarter. And also in Q2, we reintroduced our short-term product. When we first started resuming loans back and forth for last year, we were holding back on the short-term products. We reintroduced that in Q2 and you can see we funded just under $15 million in our short-term product, and have had very good demand in applications coming in on that product. Year to date, we're just under $490 million in production.

So I think we're well on our way to hitting a $1 billion for the year.

So again, continued great momentum and growth coming out of the COVID environment. And as a point of reference in July, we funded $104 million in loans.

So again, very good momentum on our loan portfolio. On Page 6, we have that type of production coming through. It continues to grow our overall portfolio.

As we said, we have a portfolio with a locked in spread under the securitizations. And you see the portfolio ended the quarter at $2.07 billion, so just under $2.1 billion.

So nice growth now for 2021 in that portfolio. And at the same time while we're growing the portfolio, we're continuing to hold our loan to value ratios low at about 66% LTV, so nice strong growth coming through and holding that LTV consistent. On Page 7 portfolio type of margin is its generating, for Q2 has generated a 4.83% net interest margin. That was an increase of 73 basis points from 4.10% in Q1, as Chris alluded to, that was mainly driven by - the increase is mainly driven by the strong NPL resolution activity of $7 million in cash, nonperforming interest comprised of prior contractual interest that came in, default interest as well as prepayment fees.

So very strong resolution month, or coming into the quarter bring this to the 4.83%. That is lumpy. It's not something that's predictable every quarter, because it's booked on a cash basis. But it was very strong for Q2. Take a look at the bottom right.

You can see that we also had a decrease in our cost of funds.

So if you look at it, overall, our yield went up to 8.41%, 8.90% on the loans due to that NPL resolution strength in Q2. But at the same time, our cost of funds decreased 20 basis points from 5.01% to 4.81% largely impacted by the securitization that we did in Q2 at a low fixed rate of 1.73%. On Page 8, we take a look at our nonperforming portfolio. Nonperforming portfolio has been trending downward since the end of 2020.

So we're actually down almost 2%, from where we ended up 2020 at 17.2% nonperforming end of Q2 this year at 15.3%.

So we had said that we were going to continuously try to bring that nonperforming rate down, it would take some time wasn't going to happen overnight. But with the special servicing department, we have low LTV on the loans and strong resolution activity that we're seeing. We're continuing trying to bring that non-performing rate down, and that's what we've seen so far during 2021 coming down almost 2%. Page 9.

In terms of the resolution activity, this gives you the kind of breakout between our long-term and short-term product for Q1 and Q2 of 2021 on the NPL resolutions, very, very strong resolutions for the year, if you added up both quarters. We had resolved over $108 million of UPB for an overall $3.6 million gain, which translates into a 3.4% gain on these NPL resolutions for 2021 over and above the contractual principal and interest.

So we've previously indicated that going back 6, 7 year trend, our NPL resolutions have always been very strong, we normally realize around a 3 point gain. And coming out of the pandemic for 2021, we're right on track at a 3.4% gain for the first 6 months of this year. Page 10 is our CECL reserve.

As Chris had mentioned, the CECL reserve we took it down from $5.8 million at the end of Q1 to just about $4 million, $3.963 million at the end of Q2 that was mainly driven by the macroeconomic forecast. Under the CECL reserve is comprised of a baseline reserve, which looks at your historical loss rate. Then under the new CECL requirements, you have to do a forward projection, adjusting that baseline reserve by a macroeconomic forecast looking forward. And we've been using a COVID stress macroeconomic forecasts we've been using that since I think second quarter of last year, when the pandemic broke out in our modeling system, we're continuing to use that COVID stress scenario forecast. But the stress forecast because of the improvement in the U.S. economy, the stress forecast for Q2 showed an improvement in the reserve needed on a go forward basis by about $900,000 versus where it was in Q1, so a nice pick up, because the improvement in the economy. And where we were sitting at the end of June, you can see as 19 basis points of reserve based on total UPB outstanding kind of as a point of reference, as of 12/31/2019 pre-pandemic, we were at 12 basis points of reserve on about a $1.8 billion portfolio.

So even by bringing that reserve down, we're still more than 50% higher in terms of a rate an outstanding UPB, now at the end of Q2 than we were at the end of the 2019 year prior to the pandemic.

So we feel very good about that reserve. And given the NPL route resolutions that we just went through resolving over 93%, 94% of our nonperforming loans with a 3.4% gain. We feel very good with the reserves that we have.

The other end the bottom right to Page 10. The charge-offs for the quarter $986,000, charge-offs were higher than Q1 of the $986,000 there was one loan that had a $420,000 charge-off.

So one loan that 4.20%, which accounted for less than half of that total for the quarter, and that loan $420,000, that was already reserved for back in Q1.

So that was already part of our loan loss reserve did not hit P&L for 2020 and Q2 was already part of a reserve, we knew about it we had reserved.

So, on a run rate basis, if you look at the 6 months to 2021. On a run rate, we're still looking at about 5 basis points of total outstanding UPB in terms of charge-offs, and that's right on top of what our historical run rate has been for the last six, seven years has been like 4.8 basis points of total UPB, first 6 months this year is 5 basis points.

So we're still right on top of our run rate for charge-offs, and I feel really good where we're at on that. Chris, I'll turn it back to you for our outlook on Velocity's business.

Christopher Farrar

Great. Thank you, Mark. I appreciate it. On 11, kind of mentioned we've seen improvement in the economy and see signs that we expect that to continue into the second half of this year. The real estate markets, as I mentioned, are doing very well. And there's been a lot of chatter about government assistance coming out for landlords and renters.

I think most of it is still working its way through the system. But we are trying to help as many landlords and borrowers and renters as we can by disseminating information, and getting the info out to them to let them know that those that assistance is available.

So I think that will also be helpful as we move forward here. And people figure out how to access those resources.

In terms of net interest income in the portfolio, growing earnings, obviously, by growing the portfolio, we see good demand across all product types. We're that basis growing the portfolio, which also should drive future net interest income and expect to continue to see that strong performance on the NPLs in terms of the capital structure. We think this next securitization, and then another one here, and probably in Q4, we expect those to go very well and see good demand there.

As I mentioned on my opening remarks, we are looking probably sometime this year to collapse a couple of the older deals and refi them, which we should be in a nice tailwind for us, which is in the warehouse line. On 12, this is a new slide for us. And last time, we promised that we were going to introduce something taking a step back, we sort of feel like the market doesn't appreciate all the value that we see in the platform and feel that our equities undervalued.

So we wanted to try to create a very simple analysis of how we look at it.

And so what we did here is, as we did kind of a buildup of this economic value. And the first chart on the - sorry, first bar on the chart is our fully diluted value of equity. That's basically just today's book value plus the conversion of $90 million of preferred equity that expect will happen in October that's the earliest we can exercise that option and based on where the stock is trading, we expect to be able to do that.

So that that gives you the first base component here, the middle section, the orange section is just a simple discounted NPV of all of the earnings we expect to make off of all of our retained interests in securitizations.

So we're calling that an embedded gain in the securitizing portfolio.

And so what we did is take all of those projected cash flows with the CPRs, the CDRs. And all of the relevant assumptions, use the 10% discount rate brought that back to today, NPV have got $222 million. And then thirdly, on top of that, just in talking with various investment bankers and capital markets folks, we're seeing a number of platforms trade in the private side. And they're telling us that typical premiums for platforms are running in the 10% to 15% of annual run rate origination and origination volumes.

So we took kind of the lower end of that and said if we did $1 billion a year and 10% of that would imply $100 million of platform value.

So, yeah, those all up you can see, in our eyes, here north of $19 of economic value per share, fully diluted.

And so, we think that is an important thing to communicate to the market and help everyone understand it. Not only do we have a great earnings story, but there is a real solid book value story here as well.

So we think that's underappreciated and hope that the market will start to recognize that value as we look at it.

So that wraps up all of our presentation here.

So I'll turn it back to Melanie, for any questions.


Thank you.

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Steve DeLaney with the JMP Securities. Please go ahead.

Stephen DeLaney

Hello, everyone. Hope you're doing well and staying safe. Great, great quarter. Love to see the progress that you're making. Gosh, a lot to unpack here. Maybe first, just if I could start with the reintroduction of the short-term bridge loans. Chris, should we view those as loans held for sale and whole loan format? And I think you did about $15 million, was a $15 million in the first quarter. Historically, what did you realize in terms of a premium gain on sale? And is that in fact the way they would be sold rather than some type of securitization? Thank you.

Christopher Farrar

Sure. Thanks, Steve. Good to hear from you.

So we are holding those on the balance sheet as held for investment right now, because we do believe we've got securitization exit in the works for those. We certainly would sell them on a whole loan basis. And when we did that in the past, what we were typically doing was taking like a participating interest.

And so, we were making a couple of points upfront. And then, on the back end, we were making an interest spread.

So, I mean, all in, if you wanted to figure something, you can probably figure like 103.5 to 104 price. But our hope is that we are going to be able to execute on the securitization strategy and just earn the spread over time, which we think could actually be more meaningful.

So we do have the flexibility to do either one, but in terms of modeling, we're going to plan to hold it.

Stephen DeLaney

Okay, great. And the NIM, obviously, 73 basis points in a quarter to 43 is a big quarterly move. And Mark explained a lot of that I think with the NPL and some of the recoveries. In your mind, as you model it out, and I don't know if Mark has built sort of 2022 models yet. But do you have any sense for looking at the - the loan yields seem crazy sticky, at least your legacy stuff, everything's like 7% and 8%.

And so, it doesn't sound like you're going to get all that much compression from - on the loan yield side, and you're going to pick up on the financing. But any sense of how much further improvement there is in the NIM, from the 4.83% in the second quarter? Do you have a target?

Christopher Farrar

Yeah, thank you.

I think we're not kind of putting out official guidance, but we think that the right number to use is probably what - it's somewhere between Q1 and Q2.

I think Q2 is a little elevated. And again, if we get 5 or 6 loans that cure that it's been delinquent for 15 months, you get all this interest in one quarter, right?

Stephen DeLaney

Yeah, yeah.

Christopher Farrar

So, that's why we were kind of trying to warn.

Stephen DeLaney


Christopher Farrar

Lumpiness, yeah.

So I think it's somewhere between the those 2. I mean, if I would probably say, it points you more towards like the 4%, 4.25% range. It's probably where we'll model NIM now. That's before the corporate debt. That's just on the…

Stephen DeLaney

Oh, sure, that's portfolio with everything else, yeah.

Christopher Farrar

Yeah, yeah.

Stephen DeLaney

Okay, great. Well, thanks for that. I'll leave some other stuff for the rest of the guys on the line. But thanks for your comments. Bye.

Christopher Farrar

Thank you, Steve.


Thank you.

Our next question comes from Stephen Laws with Raymond James. Please go ahead.

Stephen Laws

Hi, good afternoon, Chris, Chris and Mark.

As Steve said, great hearing from you. And congrats, you guys have really accomplished a lot in the last, yeah, 15 months from where we are, I think about a year ago. It really positive outlook, I think, Steve covered a good bit on the origination side with the prepared remarks. Can you maybe spend a little more time on the cost of funds seems like big opportunity there, I know, you're looking at collapsing a couple of deals? Can you try to quantify that for us, over time, where should we see that cost of funds trend? And how quickly we'll get there? And is there some inflection point in 6 or 9 months where it'll accelerate lower?

Christopher Farrar

Mark, do you want to try to hit that one?

Mark Szczepaniak

Yeah, some of the older - hi, Stephen, by the way, nice to talk to you again.

Some of the older securitizations that are close to being able to be collapsed, are currently running probably somewhere in a 5% to 6% overall cost of funds handle. And we think with refinancing, re-leveraging these in new securitizations that we could bring that cost of funds into somewhere in the 2 handle, so pretty nice pick up on that.

Stephen Laws

Yeah, thanks for that color. And, thinking about the origination business, you mentioned in the prepared remarks about own pace kind of trending for about $1 billion a year at $104 million in July. With your current platform and scale, where can that number go? Is there still significant opportunity on the upside as far as a monthly volume? Are we kind of a good pace now to see the business?

Christopher Farrar

Yeah, I think there's definitely room to go. We want to grow smartly. We don't want to get over our skis and go too aggressive. But there's definitely more run room, there's more demand.

So we think those volumes will continue to grow as we add more people and expand more relationships.

So yeah, we definitely think there's expect higher volumes next year, and I think that there's plenty of room to run there.

Stephen Laws

Great. Thanks for the comments, Chris. Appreciate your time this afternoon.

Christopher Farrar

You're welcome. Thank you.

Mark Szczepaniak

Stephen, one thing to keep in mind is we hit the billion dollars in 2019 that was offering the short-term products pretty much most of the year. And we're already almost halfway to $1 billion for 6 months of this year. And we just started offering the short-term product and reintroducing it the last quarter.


Stephen Laws

Where would you like to see that, that gives you, I think you said $15 million? Is there any kind of target maybe even quarterly run rate next year on that product?

Christopher Farrar

Yeah, we just came out of the gate with that, so we'll have to see where it goes. But I would think that it's easily somewhere in the neighborhood of $30 million to $50 million a month for sure.


Stephen Laws

Yeah, the opportunity to really grow volumes next year then. Great. Thanks for that additional color, Mark. Appreciate it.


Thank you.

Our next question comes from Arren Cyganovich with Citi. Please go ahead.

Arren Cyganovich

Thanks. The excess income that you received from penalty interest that you recovered from the quarter. Did you say that that was $7 million for the quarter? And I'm assuming you have some resolutions each quarter.

So I'm just trying to get an idea of what kind of more kind of normal levels that like half that or just trying to frame out?

Mark Szczepaniak

Hey, Arren, this is Mark. Yeah, $7 million was the actual cash received in Q2 related to nonperforming loans where we had already taken the interest income off our books, because once the loan goes nonperforming, we reverse out all the interest income and put it on nonaccrual. And then, we wait for the actual resolution of the cash to come into rebook that income.

So $7 million was actual cash that came in that was passed do contractual interest that came in second quarter. Remember, we charge a 4% default rate, was the default interest to come - either come current or pay off the loan or pay the loan current. And then depending on the loan, if it was in a prepayment window, it was to be prepayments fees as well.

So the $7 million was all cash that came in on nonperforming loans.

I think, it was about a 40% increase over Q1. But in terms of a run rate, as we said, it's really hard to project that. Yeah, I'd like to say take an average of Q1 and Q2, but I think Q2 was very high. It's probably the highest we've had since at least I know the company in terms of nonperforming resolution cash. And it's very hard to predict, because we don't book it until we get the cash and we work hard to resolve most of our loans, we get a 3% gain on them, but we just never know, when we're going to get that resolution and when that gains going to come through in cash and book it on a cash basis, it's really hard to predict that.

Arren Cyganovich

Yeah, I understand. That's helpful.

The other question I had was on a new nonperforming loan formation. Clearly, you've resolved quite a few loans for the quarter. But you also had some new additions, is the new addition there, the pace of new additions that are coming in nonperforming beginning to slow or what are your views on that front?

Christopher Farrar

Yeah, we do see that slowing the majority of those loans are folks that were in some type of COVID forbearance, and they're failing, they're just not making it.

So, I think, from that perspective, we're encouraged, that is not new originations or newer borrowers, mostly driven by folks that are already struggling.

So I think that's why you see the offset. And that's why we've been telling everyone is going to take time to kind of work through this whole backlog and as these borrowers deal with their reality, and figure out how to get resolved.

So it's mostly forbearance loans that we're incorporating.

Arren Cyganovich

Okay. All right. Thank you.

Christopher Farrar

Yeah. Thank you, Arren.


[Operator Instructions] Your next question comes from Don Fandetti with Wells Fargo. Please go ahead.

Donald Fandetti

Hi, I guess, a couple of questions. One, Chris, just checking in on the competitive dynamic. It sounds - it seems like your business has largely been very fragmented smaller private lenders. Is that still the case coming out of COVID? And are there any strategic structures you've looked at like doing more JVs and things of that nature down the road?

Christopher Farrar

Yeah. Hi, Don.

You're right, your characterization is right. It's highly fragmented. And we continue to - we think take share from smaller private lenders.

We have looked in the past at some JVs. We do have a couple in the works right now with some - and one I can think, in particular, as a private REIT that's been aggressively acquiring assets.

And so, we agreed to be their financial partner, but not necessarily a JV with another institution. But, by and large, the majority of the business is still coming through our brokers. And that's really where we're seeing the growth.

Donald Fandetti

Okay. And then, I noticed the production in the quarter versus Q1, there was more commercial. I was just curious if you could touch upon that and if you expect that to grow faster than the Investor 1-4 Rental.

Christopher Farrar

Yeah, I think our view was that we were somewhat cautious on it when we restarted back in the fall last year.

So we were just a little tougher on that product, just to make sure where COVID went and if businesses were going to be allowed to reopen and how long that was going to take.

So I attribute most of that to outlook on those borrowers and those types of assets. But I think going forward, I would expect the growth to be pretty balanced between the 2 product types.

Donald Fandetti

Got it.

Okay. Thanks [I'm also] [ph].

Christopher Farrar



This concludes our question-and-answer session. I would like to turn the conference back over to Chris Farrar, for any closing remarks.

Christopher Farrar

Thank you all for joining the call. We're obviously very pleased to present the results today and appreciate everyone taking the time to listen to our presentation and look forward to speaking to you again soon.

So thank you all.


The conference has now concluded. Thank you for attending today's presentation.

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