Earnings Call Transcript - VEL Q1 2024

Chris Oltmann, Treasurer

Good day, and welcome to the Velocity Financial Incorporated First Quarter 2024 Earnings Conference Call. All participants will be in a listen-only mode. Please note this event is being recorded. I would now like to turn the conference over to Chris Oltmann, Treasurer. Please go ahead. Thanks, everyone, and thank you for joining us today for the discussion of Velocity's first 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 first quarter results, and you can find the press release and accompanying presentation we will refer to during this call on our Investor Relations website at www.velfinance.com. I would 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. Finally, today's call is being recorded and will be available on the company's website later today. And with that, I will now turn the call over to Chris Farrar.

Chris Farrar, CEO

Thank you, Chris, and welcome everyone to our first quarter earnings call. I want to begin by expressing my gratitude to all my team members for a tremendous first quarter, as indicated by the results we released after the close. Origination volumes were nearly 75% higher than last year, showcasing strong demand in our niche, particularly since the first quarter is usually lighter in new volume. The team has been disciplined in originating target assets while managing expenses, leading to increased earnings and better returns on equity. Markets are adapting to new interest rate realities, and we observe healthy activity across the US lending segment as we step in with favorable terms where banks have backed off. The securitization market is very supportive, with spreads tightening more than base rates have risen this year, which improved the execution of our second deal in April compared to the January securitization. Additionally, 27 different investors bought bonds, and the deal was significantly oversubscribed. Our strong performance has fostered a solid investor base that believes in our program, and we've worked diligently to earn their loyalty. Regarding our portfolio, we continue to execute effectively by favorably resolving delinquent assets, and our special servicing team has excelled in driving positive outcomes. There’s ample fresh capital available to acquire the real estate securing our loans when priced right, and property values remain stable. On the capital front, we issued $75 million in new corporate debt in February to support our goal of expanding the portfolio to $5 billion in UPB by 2025. As highlighted in the press release, we have sufficient liquidity to achieve these targets as we grow. On the topic of growth, in April, we set a company record by issuing $2 billion worth of LOIs and received the highest number of new applications we’ve seen in over two years, totaling just under $400 million in combined UPB. Clearly, our pipeline is robust, and customers are responding well to our offerings. The team is enthusiastic about continuing to take market share, and our strategy of retaining earnings, growing book value, and reinvesting capital into high-return assets will drive earnings growth and enhance shareholder value moving forward. That wraps up my prepared remarks, and I will now turn it over to the presentation starting on page 3. We have achieved outstanding results from an income perspective. The core EPS of $0.51 per share is an all-time high for the company, largely driven by fair value gains from new originations and the net interest margin off the portfolio. You can see that the net interest margin has increased year-over-year, which contributed to higher pre-tax returns on equity, reflecting that many of our comparable companies do not pay taxes. Regarding production and the loan portfolio, we maintained strong production for the first quarter, which has continued into April, and our pipeline appears very healthy. The portfolio has grown significantly year-over-year, and non-performing loans are manageable at just around 10%. Most importantly, we are seeing positive trends in resolutions. From a financing and capital perspective, I've mentioned the January securitization and also completed the April securitization; the markets are currently very strong. We have ample liquidity and warehouse capacity, and, as noted, we issued new notes to support our growth. Moving to page 4, on the left side is a reconciliation of our core adjustments concerning stock transactions, and on the right side is a breakdown of book value as we continue to retain earnings and grow it. On the far right, we added two bars to illustrate the embedded gains in the amortized cost portfolio. If those gains were included in book value, it would highlight significant unlocked value. As we move forward and transition our entire balance sheet to the fair value option, we anticipate a much higher book value for all shareholders. Now, I will turn it over to Mark to begin on page 5.

Mark Szczepaniak, CFO

Thanks, Chris. Hi, everyone. Our first quarter of the year started out the year as Chris mentioned on a positive note with strong loan originations and a healthy securitization market. On page 5, loan production for the first quarter was almost $379 million in UPB that 7.5% increase from $352 million in Q4 of last year. And I think as Chris mentioned, almost a 75% increase year-over-year. The strong production growth during Q1 was achieved with the new weighted average coupon on originations at 11.1% for the quarter. And the weighted average coupon on our originations has averaged 11% for the last five quarters. The growth in originations in Q1 was also at tighter credit levels with a weighted average loan to value for the quarter at just under 64% with strong Q1 production growth at a high weighted average coupon in the low LTV further demonstrates the continued borrowing demand for our product. As a result of the strong growth in production on page 6 shows a similar growth in Q1 for our overall loan portfolio. The total loan portfolio as of March 31 was almost $4.3 billion. That's a 5.1% increase from Q4 of last year and over a 19% increase year-over-year. The weighted average coupon on our total portfolio as of March 31 was 9.07%, 19 basis points higher than at the end of last year and 92 basis points higher year-over-year. The portfolio weighted average loan-to-value ratio declined slightly to 67.6% as of March 31 compared to 67.8% as of the end of the year last year and 68.1% as of Q1 2023. So again, generating strong production at high weighted average coupons with still low weighted average loan-to-value ratios. On page 7 as Chris mentioned, our Q1 NIM decreased 17 basis points from Q4 and increased 12 basis points year-over-year as our portfolio yield remained relatively flat quarter-over-quarter, but increased year-over-year by 71 basis points while our cost of funds increased 18 basis points quarter-over-quarter and 60 basis points year-over-year. The quarter-over-quarter slight decrease in NIM was mainly driven by the timing of NPL interest, which is recorded as it's received on a cash basis. While short-term based financing rates increased during Q1. We continue to see an improvement in the overall securitization market and the strong growth in originations, coupled with the healthy NIM is reflected in our Q1 earnings. On Page 8, our nonperforming loan rate at the end of Q1 was 10.1%, compared to 9.7% for Q4 of last year and 8.7% for Q1 year-over-year. The ongoing strong collection efforts by our special servicing department have resulted in continued resolutions of our NPL loans as favorable gains. And the table on Page 9 highlights this continued success of our NPL resolution efforts. In Q1, we resolved almost $55 million worth of UPB of NPL loans and REOs, for a net gain of $1.3 million or 2.3%. We've averaged about a 2.5% gain on NPL resolutions over the last five quarters. And again, that's over and above collecting all of the contractual principal interest. Page 10, presents our CECL Loan Loss Reserve and net loan charge-offs & REO activity. The CECL reserve as of March 31st was $5.3 million or 19 basis points of our outstanding non-fair value loans held for investment portfolio and our CECL reserve is within our expected range of 15 to 20 basis points. The CECL Loan Loss Reserve as a reminder does not include loans being carried at fair value. The table to the right of the page shows our net gain loss from charge-offs & REO-related activities during the quarter. For Q1 we had a net loss on charge-offs and REO related activities of $800,000, compared to a net loss of $300,000 for Q4 2023. Page 11 shows our durable funding and liquidity position at the end of Q1. Total liquidity as of March 31st was almost $79 million, comprised of about $35 million in cash and cash equivalents and another $44 million in available liquidity and unfinanced collateral. We did issue as Chris mentioned, one securitization in Q1. In January we issued the 2024-1 security, totaling just under $210 million of securities issued. Our available warehouse line capacity as of March 31st was $529 million with a maximum line capacity of $885. In February, we entered into a $75 million five-year senior secured note at a fixed rate of $9.875 to support continued growth of the company. And then subsequent to quarter end in April, we completed our second securitization of the year, totaling $295 million of securities issued. With that, I'd like to now turn the presentation back to Chris, for an overview of Velocity's outlook on key business drivers.

Chris Farrar, CEO

Thanks Mark. Yeah. I think, as we look forward the market seems healthy and values are holding up, as I mentioned. We think it's good employment levels and the economy seems to be doing well. Capital perspective as I mentioned, the securitization markets are a tailwind for us right now. And we're very fortunate to take advantage of that. And from an earnings perspective, obviously, we're seeing the benefits pick up there and expect to continue to grow our earnings going forward, so all in all very positive and very optimistic about the future. And that wraps-up our prepared presentation. And we'll open it up for calls for questions, sorry.

Operator, Operator

We will now begin the question-and-answer session. The first question comes from Stephen Laws from Raymond James. Please go ahead.

Stephen Laws, Analyst

Hi. Good afternoon. Congrats on a great start to the year. Chris, I wanted to touch on a few things with regards to your production. April obviously started off where you're kind of on pace to meet or exceed Q2, but I noticed the LTV on new originations continues to drop. So it seems like you're sacrificing volumes to improve credit while you're able to maintain the coupon. And I just wanted you to touch on that. And what you're seeing in the market. And what that should do longer term? Should we eventually see trending down on non-performing loans? Or is that part of this type of product? And we'll eventually see larger gains on resolutions given you're attached to a more conservative level on collateral?

Chris Farrar, CEO

Sure Stephen, those are good questions. As we mentioned earlier, we are observing better opportunities at lower loan-to-value ratios, and we're taking advantage of those opportunities. However, we remain very protective of our margins. We aim to deploy capital efficiently and ensure we achieve the returns we're looking for. The way we see it, the risk-reward balance is crucial. We are not a firm that operates based on volume alone; we prioritize healthy margins in our operations. This strategy drives our decisions. I believe that delinquency will largely depend on the overall economy and how things progress in the future. With lower loan-to-value ratios, I expect we'll continue to see positive resolutions, and our forecast for those outcomes remains optimistic. We are confident in the credit dynamics we are witnessing and hope to continue our growth in that area.

Stephen Laws, Analyst

Great. And one follow-up question, kind of looking at the mix of loan production. The investor wonder for rental kind of looking at the trailing four-quarter average, 167 sort of right in line with what you've been doing, commercial's grown materially. So is that filling a void? Why are you seeing a better opportunity there? And maybe that points a little more to the competitive landscape. But curious to get your thoughts on kind of a little bit of a shift of more opportunities you're seeing on the commercial side?

Chris Farrar, CEO

Yeah, it's a good observation. I think that's an uptick as a result of the banks continuing to tighten and pull back. We're definitely seeing more demand there. We sort of set up our program on an agnostic basis where we're happy to do either product and we try to price accordingly. So we haven't made many changes there. It's mainly been a market shift where I think banks are being tougher, and so we're seeing more share.

Stephen Laws, Analyst

Great. Well, again, congrats on a great start to the year. And I appreciate your comments this afternoon.

Chris Farrar, CEO

Thank you, appreciate it.

Operator, Operator

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

Steve Delaney, Analyst

Hello, everyone. It was a great quarter, and it's nice to be with you tonight. Chris, the production growth is impressive and it's happening across the country. Can you elaborate on the regional management structure you have in place and how you are targeting specific geographic markets? I'm interested in understanding your management structure in relation to production. Thank you.

Chris Farrar, CEO

Sure. Hi, Steve. So we kind of split the country in two. We have two operation centers, if you will, on the East Coast, one West Coast just to handle the different time zones.

Steve Delaney, Analyst

Okay. Make sense.

Chris Farrar, CEO

We have various sales locations to connect with our customers. Geographically, we focus on larger metropolitan areas where properties sell more easily, avoiding rural and smaller markets where we might struggle to sell an asset for an extended period. These factors shape our portfolio strategy, and if you examine the portfolio, you'll see we are primarily concentrated on the coasts and in the Texas region as well.

Steve Delaney, Analyst

That's helpful. I assume you use the internet to contact the borrowers. Are you also coordinating with local market mortgage brokers?

Chris Farrar, CEO

Yeah. That's our primary source of business.

Steve Delaney, Analyst

I thought it would be. Yeah.

Chris Farrar, CEO

Yeah. We call them lead generators and so they basically bring us the transaction and we take over from there. And that's primarily how we market and educate folks.

Steve Delaney, Analyst

We cover United Wholesale, it's working pretty well for them in terms of...

Chris Farrar, CEO

Yeah. That's right.

Steve Delaney, Analyst

I'm not surprised that you're using that. Can you share how you've been growing these broker relationships? Can you comment on how many you have and if that's increasing over the last year or two? Are the number of touch points going up?

Chris Farrar, CEO

Yes. We are growing the number of approved brokers. We're also adding sales folks. So, by adding sales folks, they tend to bring relationships with them or prior existing contacts. And so we have a little over 2,000 approved brokers and we're adding to that list quarterly.

Steve Delaney, Analyst

Very helpful. Thank you very much.

Chris Farrar, CEO

Okay. Thank you, Steve.

Operator, Operator

This concludes our question – Oh, I'm sorry, there's another question. The next question comes from Eric Hagen from BTIG. Please go ahead.

Eric Hagen, Analyst

Hi. Thanks. I hope you’re doing well. I appreciate you including me. Regarding the REO sales, could you discuss any trends that have contributed to successfully selling those assets at a profit and how quickly you think you can work through the remaining REO pipeline?

Chris Farrar, CEO

Yes, we aim to price our REOs to facilitate quick sales. We maintain discipline to avoid appearing like a distressed lender, so we often invest a bit of effort into our REOs to prepare them for sale. This may take us longer than others, but it positively impacts recovery rates, as we usually sell them for slightly more or at least at our expected valuation. Our team is skilled in assessing potential transaction prices for these properties, and we consistently attract buyers at foreclosure sales or after listing them. It’s a process, so it will take time to work through our REOs, and we still have new ones coming in. I anticipate we'll maintain this level for the remainder of the year as new properties enter our pipeline and others are sold.

Mark Szczepaniak, CFO

Eric, this is Mark. Yes this is Mark. I think one of the things just to note is that, over 95% of our nonperforming loans are resolved by either paying off or paying current, less than 5% ever even make it to foreclosure of the REO process.

Eric Hagen, Analyst

Yes. That's helpful. Thank you. So looking at the liquidity position it's around $80 million, how comfortable do you feel there? Any kind of minimum level of liquidity you feel like you have to run with your leverage at this level? And then, are there any opportunities to call and maybe relever any of the securitized debt that you have in the stack? Thank you.

Chris Farrar, CEO

Sure, Absolutely. So yes, from a liquidity perspective, we feel very good there by retaining our earnings that's also additional fuel and capital, as we go forward. So we just continue to recycle that capital. So, we've got very strong visibility well into next year from that perspective. And then in terms of collapse opportunities, we do have two securitizations out there that one of them was sort of done on all of our delinquent assets from prior collapse deals. There's a significant amount of equity locked up there. That will roll off sometime next year. And then, there's one other transaction that we have an opportunity to pull some capital out of as it ultimately pays off or call it away. Combined, that's in excess of probably $75 million. The rest of the transactions are structured as pro rata paydowns. So we did that intentionally, because we own this risk. And so it kind of works nicely that, we're really not incented to call those deals away, because our cost of funds are staying very stable whereas in a sequential structure those cost of funds tend to spike, near the end of their lives. They stay very stable for us. So, by and large most of the deals we probably won't call or collapse until near the very end because of that stable fixed rate financing.

Eric Hagen, Analyst

That’s great. Thank you, guys so much. Appreciate it.

Chris Farrar, CEO

Welcome. Thank you, Eric.

Mark Szczepaniak, CFO

Thanks, Eric.

Operator, Operator

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

Chris Farrar, CEO

Thanks again for everybody on the call taking the time to hear our story and we look forward to catching up with everyone again, next quarter.

Operator, Operator

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