Earnings Call Transcript - VEL Q2 2024

Operator, Operator

Good afternoon, and welcome to the Velocity Financial Q2 2024 Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note that this event is being recorded. I would now like to turn the conference over to Mr. Chris Oltmann. Please go ahead.

Chris Oltmann, SVP, Investor Relations

Thank you, Rachel. Hello, everyone, and thank you for joining us today for the discussion of Velocity's second quarter 2024 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 results and you can find this press release and accompanying presentation that we will refer to today during this call on our Investor Relations website at www.velfinance.com. I'd like to remind everyone 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. Please 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. With that, I would like to turn the call over to Chris Farrar.

Chris Farrar, CEO

Thanks, Chris, and thank you all for joining our second quarter earnings call. After the close, we reported another great quarter as our business continues to perform well across all segments. Our net revenue increased 41% over the prior year's quarter, resulting in a 23% increase in core earnings. Our originations were healthy with a 63% increase in volume versus Q2 '23. Importantly, we maintained our margins and credit standards. Our portfolio is performing well and our special servicing team continues to do a great job of resolving delinquent assets favorably. Our charge-offs remain low and we realized over $2 million in net gain from our REO activity this quarter. Due to our increased originations, we issued two securitizations in April and June. Both deals priced well and saw strong demand from our bond investors. As a reminder, we're required to expense all issuance costs associated with those deals in the current period, which is a drag on current period earnings, but the trade-off has increased spreads going forward as we have no amortization expense to recognize on this debt. The real estate market is performing well for us and we continue to see strong demand for financing from our borrowers. Banks are still constrained, and we're starting to see the market price in future rate cuts, both of which should be a tailwind for us going forward. I want to congratulate all my team members on another great quarter as I truly appreciate their commitment to excellence. We will continue to execute our 5x25 growth strategy to reach $5 billion in UPB by 2025 with the ultimate goal of rewarding all shareholders. That concludes my prepared remarks and we'll turn over to Page 3 in the earnings presentation to go through some of the numbers. As I mentioned, good strong growth in core earnings, up to $0.45 a share for the quarter. The NIM widened out from earlier in Q2 of '23 by 30 bps, again, showing up as a result of the increased WAC from new originations. In terms of loan production, $422 million in UPB and total portfolio growth on a year-over-year basis of 20%. The NPL loans were up slightly to 10.5%. We continue to see positive resolutions on those NPLs and expect to do that going forward. In terms of the financing capital, I mentioned earlier that we had done two securitizations during the quarter. We highlighted here that there was a $0.06 per share drag on current period earnings from that second securitization compared to prior periods where we're typically issuing just one securitization. As I said, that's sort of a timing issue. It will depend on how many deals we issue going forward each quarter, but should also help in terms of the NIM going forward. Century Health & Housing acquired $3.6 million in MSRs from a bank that originated some recent Ginnie Mae loans. That was a great trade for us because we're continuing to build out the platform and establish new relationships with new borrowers for more business. In terms of liquidity, we're in a strong position there. You can see just under $84 million at the end of the quarter with plenty of warehouse capacity to go forward on. On Page 4, we break out the core adjustments here. And also on the right-hand side, as most of you remember, there's a buildup here to our adjusted book value per share. I will point out that we had a typo there. In the far right, if you add the $2.39 to the $14.52 of book value, it should be $16.91, not $16.81. So we're correcting that as we hold the call and that will be on the website shortly. But again, continuing to grow book value nicely as we execute on our growth strategy and retain earnings on a go-forward basis. So that covers it from me, and I'll turn it over to Mark on Page five.

Mark Szczepaniak, CFO

Thanks, Chris. Hi, everybody. In Q2, we continued our strong 2024 performance. On Page five, our loan production for Q2, as Chris mentioned, was a little over $422 million in UPB. This was an 11.5% increase from the $378.7 million in Q1. Notably, there were over 1,100 loans funded in the second quarter, indicating a great demand for the product. The strong production growth during Q2 was achieved with the weighted average coupon for the new originations remaining at 11%, continuing a five-quarter trend of 11% coupon. This growth in originations in Q2 also reflected tight credit levels, with the weighted average loan-to-value for the quarter at 64.7%. The strong Q2 production growth, coupled with the high WAC and the low LTV, further demonstrates the continued consistent borrower demand for the product. As a result of this strong growth in production, Page six shows we see a similar growth in Q2 for the overall loan portfolio. Our total loan portfolio as of June 30 was almost $4.5 billion, marking a 4.6% increase from Q1 and over a 20% increase year-over-year in the portfolio. The weighted average coupon on this portfolio as of June 30 was 9.25%, which is an 18 basis point increase from the Q1 weighted average coupon and an 85 basis point year-over-year increase. The portfolio weighted average loan-to-value ratio remained consistently low at 67.4% as of June 30. On Page seven, our Q2 portfolio NIM increased 19 basis points from Q1 and 30 basis points year-over-year as our portfolio yield component increased by 27 basis points quarter-over-quarter and 74 basis points year-over-year, while our cost of funds increased only by 8 basis points quarter-over-quarter and 43 basis points year-over-year. This quarter-over-quarter increase in NIM is mainly driven by the strong loan production growth in the quarter and healthy spreads, the higher coupons, and also due to the recent improvement in the securitization market, which kept the cost fairly low. On Page eight, our non-performing loan rate at the end of Q2, as Chris mentioned, was 10.5% compared to 10.1% for Q1. Our non-performing loan rate has remained consistent for the last five quarters and ongoing collection efforts by our special servicing department continue to result in resolutions of our NPL loans at favorable gains. The table on Page nine highlights the continued success of the NPL resolution efforts. On a trend basis, we continue to average about 2% or more overall gain on NPL resolutions over the last five quarters. Page 10 reflects our CECL loan loss reserve and also the net loan charge-off and REO activity. On the bottom left-hand chart, the CECL reserve as of June 30 was $5.2 million or 20 basis points of our outstanding non-fair value loans held for investment portfolio. The CECL reserve is within our expected range. The CECL loan loss reserve number does not include our loans being carried at fair value. It's only the amortized cost. The table to the bottom right shows our net gain and loss from loan charge-offs and REO-related activities during the quarter. For Q2, we had a net gain on loan charge-offs and REO-related activities of a little over $2 million compared to a slight net loss of $800,000 for Q1. This indicates we're doing really well on loan charge-offs, selling a lot of these REOs and again booking a net gain activity for the quarter. Page 11 shows our durable funding and liquidity position at the end of Q2. As Chris mentioned, our total liquidity as of June 30 was just under $84 million and that's made up of over $47 million in cash and cash equivalents and about $36.5 million in available liquidity on our unfinanced collateral. As a result of our strong loan production, we issued two securitizations in Q2. In April, we issued our 2024-2 security with $286 million of securities issued, and in June, we issued our 2024-3 security with almost $205 million of securities issued. Our available warehouse line capacity was $646.5 million at the end of the quarter with a maximum line capacity of $885 million. So, we still have plenty of available capacity on our existing warehouse lines to support future growth for the company. Now, I'd like to turn the presentation back to Chris to overview Velocity's outlook on key business drivers.

Chris Farrar, CEO

Thanks, Mark. Yes, looking forward, we feel good about where we're headed. The markets are healthy, and we see good activity on both the real estate side and the borrower side. In terms of credit, we are seeing a lot of mixed signals out there. It feels like the Fed is probably going to implement some softening here. However, we do expect to continue to get those positive NPL resolutions moving forward. The securitization market is healthy and feels good going forward. So, we are very positive there. From an earnings perspective, we will continue to execute like we do, and we think that things look very good for the future. So with that, we'll open it up for questions.

Operator, Operator

Thank you. We'll now begin the question-and-answer session. The first question comes from Stephen Laws with Raymond James.

Stephen Laws, Analyst

Hi, good afternoon. Congratulations on a very nice second quarter. Chris, I want to touch on Page five with the loan production. Really strong across the board. Investor loans have rebounded from some seasonality in Q1, showing consistent growth in commercial and particularly short-term loan products. This $103 million in originations, do you think this is the right level? What's your outlook?

Chris Farrar, CEO

Stephen, I think you cut out a little bit there, but I believe your question was just what we think on production levels going forward. Yes, I would expect for the rest of the year around this Q2 run rate feels right. The product mix can sometimes move around a little bit, but I believe it will be somewhat similar to what you're seeing here in Q2. So, yes, we think for the rest of the year, it should look pretty similar to that.

Stephen Laws, Analyst

And do you have an update on the adjusted book value and the rate moves quarter-to-date? Curious about how that fair value mark may have changed as of the end of July.

Chris Farrar, CEO

Yes. If we were to mark today, you're right; there would definitely be a positive change. It's largely dependent on where things settle out at the end of the quarter. So, if things were to stay where they are today, yes, I believe you'd see an increase in the overall book from the drop in base rates for sure.

Stephen Laws, Analyst

Lastly, Chris, comments regarding whether you've seen any banks return to the market. Are they continuing to put up 11% coupons? It doesn't seem too competitive. What are your thoughts?

Chris Farrar, CEO

Not hearing much there. We are seeing a lot of borrowers come to us that I believe normally would expect to be handled by the banks. I'm not really seeing any signs of that, and all the feedback is that they are very constrained and limited in terms of new credit.

Stephen Laws, Analyst

Great. Well, congratulations again on a nice quarter. Thanks for the insights.

Chris Farrar, CEO

Thank you. I appreciate it, Stephen.

Operator, Operator

Your next question comes from Steve Delaney with Citizens JMP. Please go ahead.

Steve Delaney, Analyst

Good evening everyone. Great quarter. Remarkable, Chris, the consistency of your production and the market is the market. Do you tie that to your relationships with brokers and borrowers? Is it a defensible market presence that you have, ensuring that someone is not going to come in and undercut you on rates?

Chris Farrar, CEO

Yes, I believe so. We've always thought this was an underserved niche. It's highly fragmented, and we find many different players out there. By sticking to our knitting—since we are a portfolio lender—our spread income allows us not to feel the same pressure that other originators do to heavily increase volume. We can maintain a disciplined margin. Our customers recognize our reliability and certainty of execution, and that loyalty shows in our margins and production volumes.

Steve Delaney, Analyst

You've maintained a commitment to a target of 11%. Since late May, the 10-year is off 70 bps. If we get three or four rate cuts over the next six to nine months, will that impact your rates? How are you thinking about it internally?

Chris Farrar, CEO

Good question. We lowered rates a couple of weeks ago, monitoring the bond markets, taking rates down by 0.25 point. We may not move in lockstep with the markets due to volatility. We price our debt mainly off of shorter bonds, tapping into the three to five-year durations. We keep watch on those rates and will adjust to those base rate movements. If the trend continues, we will follow the market and pass that along to our borrowers while maintaining our spread.

Steve Delaney, Analyst

Your securitizations are fixed-rate funds. The only benefit you would get on the liability side would be if your warehouse lines are floating. Is that right?

Chris Farrar, CEO

Right. Correct.

Steve Delaney, Analyst

You've been beating estimates every quarter, so we might need to adjust them going forward.

Mark Szczepaniak, CFO

Don't crank it up too much, Steven.

Steve Delaney, Analyst

Congrats, guys.

Chris Farrar, CEO

Thanks so much. Thank you, Steven.

Operator, Operator

Your next question comes from Eric Hagen with BTIG. Please go ahead.

Eric Hagen, Analyst

Hey guys, good afternoon. Following up a little on the origination side—operationally and underwriting-wise—are you originating at capacity right now? How much more operational leverage do you think you can potentially extract with your current cost structure?

Chris Farrar, CEO

Yes, Eric. We've invested significantly in technology. To achieve 1,000 units a quarter, you have to have that in place. I believe we have excess capacity—around 10% to 20% more. As we approach the end of the year, we may increase some headcount to accommodate growth, but it's marginal and not too significant. We can add quite a bit more volume with minimal adjustment to the cost structure.

Eric Hagen, Analyst

Thank you for the context there. What do you feel is the all-in ROE from originating and delivering into securitization with spreads at these levels? Do you have a benchmark for the two deals from last quarter? If securitization spreads tighten, what would that mean for your ROE?

Chris Farrar, CEO

Yes. We believe the ROEs are north of 25% at these levels. If spreads tighten, we would see benefits over a multiyear period, benefiting from locking in fixed-rate loans against fixed-rate debt. If we observe some tightening in spreads, that could significantly boost ROE for our new deals.

Eric Hagen, Analyst

Really helpful. Thank you so much.

Operator, Operator

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

Chris Farrar, CEO

Thank you, everyone, for joining the call. We appreciate your support and will continue to execute on our plan. We look forward to speaking with everyone next quarter. Thank you.

Mark Szczepaniak, CFO

Thank you, everybody, for your time.

Operator, Operator

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