Earnings Call Transcript - VEL Q3 2021

Operator, Operator

Good day and welcome to the Velocity Financial Inc. Third Quarter 2021 Earnings Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Chris Oltmann, Chief Accounting Officer. Please go ahead.

Christopher Oltmann, Chief Accounting Officer

Thank you, Glenn. Hello, everyone, and thank you for joining us today for the discussion of Velocity Financial's third quarter 2021 results. Joining me today on the call are Chris Farrar, Velocity's President and Chief Executive Officer; and Mark Szczepaniak, Velocity's Chief Financial Officer. Earlier this afternoon, we released our third 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 SEC. Also note that the content of this conference 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.

Christopher Farrar, President and CEO

Thanks, Chris, and welcome everyone to the third quarter call. We had an outstanding quarter and set several historical records. I want to express my gratitude to my team members who work diligently every day to achieve these results. Our employees are highly engaged and take pleasure in helping our customers succeed. There is strong demand for our products, and the real estate environment is robust, particularly in the BPL segment, which is experiencing a significant supply-demand imbalance and favorable securitization markets, as reflected in our operating results announced today. Regarding originations, we funded just over $340 million in new loans in Q3, surpassing our previous record of $321 million funded in the fourth quarter of 2019, which was before the pandemic. Our investments in automation and systems have enabled us to operate more efficiently than ever, and we are gaining momentum. There's been much media coverage on rising mortgage rates, but we’re happy to report that our new applications continue to rise, consistent with our historical experience in previous rising rate environments. September and October were sequentially record-breaking months for the dollar amount of new loans submitted, with over $410 million in new applications submitted through our broker portal in October, again breaking the pre-COVID record of $316 million set in October of 2019. In terms of asset quality, we are pleased with the ongoing reduction in non-performing loans, and our special servicing team has effectively worked with customers to resolve issues. Most loans are settled well before final foreclosure, and we have very few delinquent loans turning into REO. On the financing side, our capital markets team has been active in keeping up with our new originations, closing our third deal of the year in October, with a fourth securitization planned for December, which is benefiting from lower-cost securitizations. Our goal for 2021 was to fund a billion dollars in new loans, and I'm excited to share that we will achieve that goal by next week. As we capture more market share and grow our portfolio, we are focused on enhancing customer service levels, encouraging our team to learn, and creating new opportunities for investors to finance their real estate while aiming to increase shareholder value. Our team is well-prepared to leverage the favorable market dynamics specific to our sector, and we are confident in our growth potential. We appreciate the continual support from all stakeholders and will now delve deeper into our earnings materials. To start on page three, this quarter proved beneficial from an earnings standpoint. I primarily focus on core earnings, which have slightly decreased from the previous quarter. It's important to note that in Q2 we generated about $2.5 million from loan sales but did very little of that in the third quarter. Had we continued at that rate and sold loans, core earnings would have been significantly higher. As mentioned in the past, we assess these decisions and aim to be strategic about when we sell home loans and securitize. Our preference leans toward securitization, so those gains, not recognized this quarter through potential whole loan sales, will certainly be accounted for in the future. I’m very pleased with the strong earnings, particularly in net interest margin and good interest income growth as we added new loans. From a production standpoint, I mentioned we had a record quarter. Our portfolio is expanding nicely, which has led to a 260 basis point decrease in non-performing loans quarter-over-quarter. We are steadily addressing the backlog of COVID-related issues and seeing positive performance in that area as well. In terms of financing and capital, the securitization market has been advantageous for us, and we expect it to remain strong. We have implemented an ATM program and are glad to have it operational. We sold a small amount of stock to ensure that all necessary processes are in place, making it a beneficial program for us as we continue to expand. Lastly, on slide three, we increased the size of one of our facilities from $100 million to $200 million and extended the renewal period to two years. We have solid support and are in a strong position in terms of financing and capital. On page four, following the quarter-end, we confirmed the conversion of the preferred shares, which eliminates uncertainty about potential future developments. I also mentioned the closing of that third securitization in October. Overall, we are gaining great momentum. Now, I'll hand it over to Mark to guide you through the remainder of the presentation.

Mark Szczepaniak, Chief Financial Officer

Thanks, Chris. Good afternoon, good evening, everybody. On page five, core income and book value growth, our GAAP income and core income were the same for Q3; there really were no unusual items, so $8 million for the quarter. As Chris mentioned, that's comparable to a core income of $8.5 million for Q2. But in Q2, we did sell more loans; we had an overall gain on sale of about $2.2 million, whereas we only had a gain on sale of about $500,000 in Q3 because we made a conscious decision to hold more of our originated loans and put them into securitizations. As we'll see in the next couple of slides, our NIM has widened out because the securitization cost has come down. So we thought it very prudent to put more loans into our securitizations and kind of build that go-forward locked-in spread. But if you did it on a normalized basis and took out that $2.2 million gain in Q2 and put in just the $500,000 that we had in Q3, on a normalized basis, the run-rate Q3 core income was actually about 11% higher than Q2 on just a pure NIM basis. Looking at the book value per share, you can see that quarter-over-quarter it's increased from $11.62 a share to $12.05 at the end of the third quarter. Looking at loan production, we achieved a record for the company in Q3, with just under $341 million of production. In October, we actually surpassed $138 million just for the month. That's a record for the company for a single month. As Chris mentioned, the appetite for our product is out there, the real estate market is very strong, and we're seeing great production numbers. On the loan portfolio, this kind of gives you a look at the portfolio, we ended the quarter just under $2.3 billion compared to about $2.1 billion for Q2. The growth we've been experiencing throughout the last four or five quarters has been good growth in all of our products. It's not any one product taking off more than the other; it's good growth across all the products. While we're growing our production and our in-place portfolio, at the bottom of that slide, you can see that our LTVs are holding very consistent, right around 66%-67%, and the average loan balances are staying right around $350,000. Everything has been consistent in terms of our commitment to quality and LTV, and good credit while simultaneously growing production. Our net interest margin for the third quarter was 4.97%, a 14 basis point increase over Q2's net interest margin of 4.83%. That was mainly driven by the declining cost of funds. If you look at the right-hand side, our average cost of funds from Q2 to Q3 declined from 4.81% to 4.48%. As we continue to put on these lower-cost securitizations, we're reducing our entire total cost of funds and widening our NIM. You can see the net interest income for Q3 was $26.6 million compared to $24.4 million for Q2, about a 10% increase there. Our loan investment portfolio performance, as Chris mentioned, some of the higher non-performing loan ratios that we experienced during the peak of COVID, towards the end of last year and with our COVID forbearance program, we've been continuously working that off and have been very successful with our special servicing department resolving these issues. We ended up the quarter at a 12.7% non-performing rate, which is a drop compared to 15.3% at the end of Q2, and if you go back to the end of last year, we were at 17.2%. So coming out at the end of nine months is a success in working off these non-performing loans, and again, with very little going to foreclosure, we're resolving them successfully by either paying off or keeping current. If you look at the next slide, you can see what's happening there. We're maintaining that very successful non-resolution activity with high collection rates and low REO. We're continuing to make positive gains on these non-performing loans over and above the contractual principal and interest due to the collection of default interest and the long-term loans on the prepayment fees. Keep in mind the short-term loans are subject to prepayment fees, but we still collect default interest. Overall, we are still making a nice gain on loan resolution. Our CECL reserve stayed fairly constant from Q2 right around the $4 million mark, just under 44 million for Q2, and we're like around 18-19 basis points. We feel very comfortable with that level. At its height, it was like 29 or 30 basis points due to the macroeconomic forecast. If you recall, we used a COVID stress scenario macroeconomic forecast in our CECL model. During the height of the COVID pandemic, all the economic factors that went into that macroeconomic forecast were stressed heavily, causing the reserve to go up. Now those same economic factors have returned to a more normal status, or at least close to normal, so that macroeconomic forecast comes back with less severe reserve requirements. Now we're running right around 18 to 19, which is a couple of basis points compared to pre-COVID levels at the end of 2019, when we were around 12 to 13 basis points. So even bringing it down, we're still 1.5 times what our reserve was running pre-COVID. So we're very comfortable with that as our loan production continues to grow. Charge-offs for the quarter were very low at about $162,000, getting closer to our normal charge-off rate of around $350,000 per quarter, if you go back several years, so $162,000 is starting to come back down to where we expect. I think you'll see those charge-offs declining because that non-performing loss rate is also coming down. Chris, I’ll turn it over to you for the outlook for the go-forward business.

Christopher Farrar, President and CEO

Great, thanks, Mark. Slide 12 just kind of sums up in terms of the addressable market, seeing very good activity and strength. We believe that rising mortgage rates actually help us as our clients tend to look for alternative ways to generate revenue and often end up originating the types of loans that we focus on. We see a number of good factors out there that give us a lot of confidence in the forward outlook in terms of demand. On the financial performance, we believe that building the portfolio and having that stable earnings stream will continue to grow as we add more loans. We expect improvement in delinquency rates because we've come from such a high level, but we still expect improvement to get back down to normal levels sometime next year. From the liquidity and capital perspective, we've taken various steps, and we have access to capital both in the short term from the warehouse side and the long term from the capital markets through securitization. So we're feeling good about our capital position. The last final mention is on slide 13, where we introduced this last time, the economic value of book equity. As you know, most of our competitors use fair value accounting; we do not. We carry our loans at amortized cost. We feel it's important to layout if we were to do some type of fair value presentation. We think that would impact our presentation of the balance sheet. We've built up a view not only on the fully diluted value of equity but the embedded gains in the portfolio as well as the platform value. There has been a trend of platforms trading in the last quarter or so around the sort of 10% of annual production level, so we believe 150 million plus is very fair for the platform value. You can see there’s a significant pick-up in book value of equity under this method. This will wrap up our formal presentation, and we'll open it up for questions now.

Operator, Operator

The first question today comes from Stephen Laws with Raymond James. Please go ahead.

Stephen Laws, Analyst

Hi, good afternoon. Fantastic progress on the NPLs, and I also noticed that there's a continued decline in your 60-day delinquencies of performing loans. It seems like you're making a lot of headway there. Is there any type of target you look at? You guys came public right before COVID hit, unfortunate timing, but how do we think about a normalized NPL level and kind of what's the glide path to that over the coming quarters?

Christopher Farrar, President and CEO

Sure. Hi, Steven. We guided folks on the roadshow to a 7% to 9% range for delinquency; that's historically where it's been over the last 15 years, and that's where we expect to end up. We're making good progress there. We aren't having any delays or problems for closing or running through the court system, so sometimes it's just a matter of the clock running out on people and forcing them to make a decision. We think by the latter half of next year, we'll be back into that sort of normalized range. It's difficult to predict exactly, and that could be off by a quarter or two. But as long as we continue to see the trend going that way, we'll be pleased.

Stephen Laws, Analyst

Great, thanks, Chris. Thinking about the NIM, I see that it continues to widen again this quarter. Can you talk about the legacy deals that have some higher rates attached to them? How are those paying down, and are there any opportunities to collapse those and re-securitize those loans that could further reduce that financing cost of the portfolio?

Christopher Farrar, President and CEO

Sure. Yes, we are constantly monitoring all of those deals; each one has a different call level. We're working on a couple of them right now that we think we can call in the fourth quarter. Next year, we'll probably be able to call a few more. We have to make sure we check all the boxes and line everything up, but we definitely intend to do that. I think there are some pretty significant savings there. Even though some of these older deals are a smaller portion of the overall financing, it'll still be a meaningful pickup. So yes, we expect that to help us over the next few quarters, definitely next year as well.

Stephen Laws, Analyst

Great. Last question for this afternoon. You've cited in your last page some of the transactions of other platforms being acquired in the space. Certainly a lot of people looking to get into the BPL Industry. How has competition changed as some of those platforms are now on bigger balance sheets? Have you seen material pricing pressure, or is it too soon to tell since many of those transactions just occurred? Does that change the competitive landscape at all?

Christopher Farrar, President and CEO

Yes, we haven't seen any pressure on our pricing. I'm sure the competitive landscape is constantly changing. A lot of these platforms operate in different niches. We don't really have anybody stepping on our toes right now. In the fix-and-flip space, a lot of people are going after that, but we do very little of that. We always have competition, but we're not feeling any pricing pressure or anything that is forcing us to act irrationally.

Stephen Laws, Analyst

Great, thanks for the comments this afternoon.

Christopher Farrar, President and CEO

Thank you.

Operator, Operator

Our next question comes from Don Fandetti with Wells Fargo. Please go ahead.

Donald Fandetti, Analyst

I just had a question. Obviously, your originations continue to ramp up very nicely. What are you doing internally in terms of trying to increase marketing and broaden that for larger originations over the next year or so?

Christopher Farrar, President and CEO

Yes, hi, Don, it's a good question. We've got a number of marketing initiatives that our team has undertaken, and they're doing a great job of driving traffic to our website and generating leads. We're doing virtual presentations, we're attending trade shows, and we're taking various other steps to increase visibility. We're also adding account executives and trying to expand in markets where we have less penetration. All of these efforts combined are showing up in our results, and we believe that will continue next year as well.

Donald Fandetti, Analyst

Okay, and just kind of a follow-up to your last question. Typically, in these types of markets, when they're hot and origination volumes are strong, yield compression tends to occur. Is that something we should all just assume will happen? I know you're not seeing it currently, but is that something we should prepare for as we head into next year?

Christopher Farrar, President and CEO

We're not forecasting it for our model. I don't know how to predict the broader market, whether or not that will happen. We price our rate sheet based on where we can execute in the securitization and capital markets, and that really drives our pricing. I don't know if we'll see a bunch of crazy competition come in and start driving yields lower. I kind of don't think so, because what I tend to see is a lot of our competitors offer other products, as opposed to just the types we focus on. I don't see two big players trying to use pricing to gain market share. We believe we can maintain our spreads going forward; we've done it over the last 15 years and think it'll continue.

Donald Fandetti, Analyst

Thank you.

Operator, Operator

Next question comes from Steve DeLaney with JMP Securities. Please go ahead.

Stephen DeLaney, Analyst

Hi, everyone. The highlight that really jumps off the page, Chris, is the 33% sequential growth in volume, and also your commentary about how vibrant and strong your target markets are. On page six, you mention, and I think you said you're probably being modest about how good this is happening for you. I'm sure you talked about adding up. I'm sure it’s a lot of effort from you and the team resulting in that 33% growth; it's more than just a strong market. You didn't mention the introduction of lending products. Could you highlight or comment on what new products you brought out to the market that you think might have contributed to the growth and will help going forward? Thanks.

Christopher Farrar, President and CEO

Sure. Absolutely. Firstly, you're right that this is primarily due to heavy lifting and hard work from our people, which is the main driver. Regarding products, we did introduce some short-term products that help; the more options we provide for salespeople to discuss with clients improves our chances of landing business. We haven't really tweaked our programs to a level that I could point to and say this particular change drove 20% of that increase. It’s more of a combined effort showcasing our hard work paying off.

Stephen DeLaney, Analyst

Yes, and it's clear that you're focused on the investor market. Just looking at the bar chart, there’s a lot of growth driving that. So, if you've got that work and don't want to spend too much energy on creating distractions with marginal changes that may not really move the needle.

Christopher Farrar, President and CEO

That's right.

Stephen DeLaney, Analyst

You made a comment about your customers and taking the time to do more of this business. If I think about a loan broker who, for the last two years, was just crushing refinances for near-prime borrowers—no-brainer borrowers—pumping out agency refinances, even with marginally higher rates, how does that game slow down? Regarding competition, is it just a matter of these loan brokers having the capacity and the opportunity to look for something else to do now that they aren’t as busy?

Christopher Farrar, President and CEO

Yes, your premise is spot on. If their phone starts to slow down, they can go back to those previous customers. When looking at those loan applications, it's amazing how frequently borrowers own other properties, creating further opportunities. In many situations, they also need to generate revenue and start marketing our product; we have several successful clients that exclusively market our product. We provide marketing materials to our brokers, showing them how they can effectively allocate their dollars to expand their business in this space.

Stephen DeLaney, Analyst

Do you think your product holds a competitive advantage? Obviously, agency investor products have their limitations, and the documentation is intensive. Are there distinguishing factors that make your products or process more accessible for borrowers, compared to agency options?

Christopher Farrar, President and CEO

Yes, absolutely. You've nailed it. We've never believed that caps were much of a concern for our business. To your point, clients seeking alternative products are often less inclined towards us due to the complexity of agency offerings. Our historical focus quite frankly has been on a different segment of the market. From talking to our account executives, there’s a noticeable openness in brokers now to what we have to offer. Minds are starting to open because, as you mentioned, shifts are happening on that side.

Stephen DeLaney, Analyst

Great. Great insights. Appreciate the conversation and stay well.

Christopher Farrar, President and CEO

Thank you. You too, Steve.

Operator, Operator

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

Arren Cyganovich, Analyst

Thanks. The rising home price depreciation, I would imagine is helping you in two respects: by increasing the size of loans needed for your single-family rental and also aiding in resolving any of your past-due loans. At what point does the rising home price appreciation become an issue or potentially a net negative?

Christopher Farrar, President and CEO

Yes, hi, Arren, good question. Personally, I hope for a very soft, flat market, kind of an annual 1% growth rate; I think those are the healthiest markets because they maintain balance. A continued high pace could present affordability challenges. However, we've seen several pockets across the U.S. where that acceleration is definitely slowing, which I believe is a healthy sign for everyone. We'll need to keep an eye on that as next year unfolds, but if it stays in double digits for a few more years, that would definitely be a concern.

Arren Cyganovich, Analyst

Regarding the reduced cost of funds, as you continue to issue new securitizations at more attractive pricing, do you expect to pass on some of that to acquire new borrowers or make your product more appealing?

Christopher Farrar, President and CEO

Yes, we definitely pass along those benefits. They show up in our rate sheet depending on how we execute. We determine where we need to be from a spread perspective, along with our ROE targets—that's where we set our rates. If our competitors are higher or lower, so be it. We simply want to stay disciplined, ensuring we maintain appropriate risk-adjusted returns on our capital. We continuously deliver those benefits to our customers.

Arren Cyganovich, Analyst

Lastly, maybe Mark can help with this one. You're issuing a small amount of equity via your ATM. Is there a metric we should watch concerning leverage and equity that can guide us in terms of projecting how much equity you'll need and how much you'll be issuing?

Mark Szczepaniak, Chief Financial Officer

Out of the ATM, we didn't issue much in September because when the ATM became functional, we only had four or five trading days left in our open trading period. We have blackout periods, so we only had a few trading days. That's why we only issued about 10 or 11,000 shares. It depends on the average trading volume; we’re cautious about not issuing a significant percentage of that average trading volume. We monitor that very closely, adjusting our ATM issuances based on a certain percentage of the average trading volume. The number of issued shares has also recently increased with the conversion of preferred shares to common, so we need to observe how that impacts average trading volume.

Arren Cyganovich, Analyst

Is there a guiding leverage factor you're aiming for or any metric that can aid in our modeling?

Christopher Farrar, President and CEO

Yes, I’ll address that. We've been consulting with bankers, and we believe we need to be around our current levels. We aim to stay within the 5.5% to 6.5% range for leverage, depending on how we grow. We’ll add a bit of equity, a bit of debt, in accordance with our balance sheet status, but I think this leverage level is where we intend to remain.

Mark Szczepaniak, Chief Financial Officer

I agree; I’d say around 6% is optimal for us. Perfect.

Arren Cyganovich, Analyst

Okay, perfect. Thanks so much.

Operator, Operator

Ladies and gentlemen, this will conclude our question-and-answer session. I would like to turn the conference back over to Chris Farrar, CEO for any closing remarks.

Christopher Farrar, President and CEO

Great, thank you all for taking the time to listen to our story. We appreciate it and look forward to talking to everybody after the end of the year. Thanks, everyone.

Operator, Operator

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