Earnings Call Transcript - VEL Q2 2022

Operator, Operator

Good day, and welcome to the Velocity Financial Inc. Second Quarter 2022 Conference Earnings Call. All participants will be in 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, Treasurer and Director of Investor Relations. Please go ahead.

Chris Oltmann, Treasurer and Director of Investor Relations

Thanks, Andrew. Hello, everyone, and thank you for joining us today for the discussion of Velocity Financial's second quarter 2022 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 2022 press release and the accompanying presentation, which are available now 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. 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. And with that, I will now turn the call over to Chris Farrar.

Chris Farrar, President and CEO

Thanks, Chris, and welcome everybody to our second quarter earnings call. Before we dive in, I want to recognize our CFO, Mark Szczepaniak, for his recent award from the Los Angeles Times as CFO of the Year. Anyone who's worked with Mark knows he's a true leader and a genuinely great person; his commitment and work ethic permeates our culture, and we're very fortunate to have Mark on our team. So congratulations, Mark, on a well-deserved award. In terms of our results, we reported another outstanding quarter in an obviously uncertain time. Our unique portfolio approach continues to generate stable earnings with limited volatility. Originations moderated this quarter as our recent coupons increased to the mid-8% range. And fortunately, we're continuing to see healthy loan submissions at those levels. We're currently in the market with our fifth securitization of the year, and we're pleased with the strong support we've seen from our investor base. For seasoned loans, our delinquency continues to normalize, and our special servicing team consistently delivers impressive results. We're beginning to see a cool down in the real estate market, which we think is healthy, and there are still plenty of loan opportunities for us to invest in. Due to the recent market volatility, we're also being shown some interesting opportunities to acquire good assets from distressed operators. We intend to capitalize on those situations as they develop in the second half of this year. From a liquidity perspective, we're in the strongest position we've had in many years. Due to our stable portfolio earnings, we can be patient in deploying our capital and we will manage our liquidity carefully as the market evolves over the next six to twelve months. Despite the recent headwinds, we are very confident in our ability to grow and deliver strong returns for our shareholders. With that, I'll turn over to the presentation materials, starting on page 3. Looking at the second quarter from an earnings perspective, nice strong earnings of $10.6 million, both on a core and GAAP basis, a healthy increase year-over-year. Down a touch from the first quarter on a core basis, and that's mainly driven by fewer loan sales. We made more loan sales in the first quarter and in the second quarter decided to securitize more assets. And as we've said over time, we'll be opportunistic when we make those sales. From a net interest income perspective, it was up almost 25% year-over-year. So very good strong net interest income growth as the portfolio grew and an exceptional quarter from the NPL recovery rate of 111% over accrued interest and outstanding UPB. We saw some really nice pickups from some older seasoned loans that had been unresolved for a long time and a couple of REO gains. So just great performance there. In terms of production, you can see year-over-year about 74%, so very nice growth on a quarterly basis. And then for the first six months of the year, over $1 billion, which is more than twice the amount that we had done in the prior year. So fantastic growth across the platform. We ended the quarter with $3.1 billion in terms of UPB. And as we've come out of COVID and started to see borrowers get back on their feet, we've seen the nonperforming rate reduce dramatically. From a financing and capital perspective, we completed three securitizations during the quarter. I think that speaks to our strength out there in the track record and the history that we've had of bringing good deals to market. And so we're proud to be able to continue to execute in choppy times. One of those transactions was a refinance of a deal that we've done during the heart of COVID, and we had a tremendous amount of capital tied up in that transaction. So that freed up a lot of liquidity for us. And probably, in my mind, one of the most important highlights of the quarter is we ended with $134 million at the end of the quarter, which really puts us in a good position to not only take advantage of interesting opportunities but also just patiently watch and see how markets develop. Lastly, we did increase warehouse capacity another $100 million during the quarter. And as a reminder, all but one of those facilities is non-mark-to-market. So we've eliminated that risk almost entirely across the portfolio with securitization and non-mark-to-market facilities. Turning to Page 4, you can see book value per share at $11.26. I think this slide highlights our unique portfolio approach of building book value and trying to maximize shareholder return with limited volatility. So a number of our peers are seeing big marks just based on market volatility and our sort of approach and accounting methods, I think, eliminate a lot of that. So I'm proud of how the business has performed. And with that, I'll turn it over to Mark to handle the rest.

Mark Szczepaniak, CFO

Thanks, Chris. Good afternoon, good evening, everyone, and thank you, Chris, for the kind words. Of course, I had to pay him enough to say all those things, but that's a different story. On Slide 5, for loan production, as Chris mentioned, we have very strong loan production for the first half of this year, a little over $1 billion compared to about $489 million for the six months of 2021, which is a 110% increase in production. We only had $1.3 billion fundings for all 12 months last year. So, we're at $1 billion for six months, we're still seeing very strong demand for our product. We have $445 million funded in Q2. As we've seen a little bit we've been raising our WACs on our loans to kind of keep up with the interest rates that we're seeing on the finance side to maintain that spread. You see that in just a moment. So, even after raising our WACs and actually our Q2 production, new originations on Q2, our weighted average coupons were up 145 basis points from the new originations that we had in Q1. So, we've been aggressively raising the rates and still seeing good, strong production coming in, in Q2 and again in the first six months of the year. So, very happy to see that. On Slide 6, the production comes in strong, the loan portfolio is growing accordingly. We're putting most of that into our portfolio, our in-place portfolio with our lot spread. Our total loan portfolio at the end of June was $3.1 billion, that's up 7% from $2.9 billion as of the end of Q1 and up 49% year-over-year compared to June of last year, again, just showing the very, very strong demand for our product. And the weighted average coupon was 7.53%, and that's up from 7.50% for the first quarter. So, again, we're raising the rates, getting the coupon up to offset the rising interest rates on the financing side and still getting in the volume and able to grow the portfolio significantly. On Slide 7, the net interest margin, what we're seeing is more of a return to normalized levels in our NIM. If you go back to second quarter of last year, you can see on the page, it was up at $483 million. We had said in some previous calls that, debt margin was inflated. We're getting higher margins because we're getting a lot of the default interest, prepayment penalties as we were bringing the NPL rate consistently down. So, that yield coming through was not a sustainable yield over the long haul and we normally run around a four-point margin. We're normalizing back to kind of our normal run rate margins, and we feel really good about that. And as our non-performing loans are resolved, the default interest in prepayment fees have kind of started to normalize because our NPL rate has come significantly down, and we will take a look at that. But while we're doing that, we're still maintaining our spreads. If you look at the right-hand side, the portfolio yield and cost of funds, you can kind of see you go back to Q2 of last year when interest rates were higher, we were charging more on the loans and of course, our debt costs were a lot higher at 4.81%. As Q1 came into play and rates came down in the second half of 2021 into the first quarter of 2022, we lowered the WAC on the loans, still maintaining that spread. We've been very aggressive now going into Q2 and through Q2 as interest rates have gone back up on the financing side. Again, as I said, we've increased the WACs almost immediately to keep that yield on our loans and still maintaining that spread throughout. On Page 8, the asset resolution activity. We continue to see strong resolutions on our NPL resolutions for Q2, $50 million in UPB for a $5.7 million gain, that's an 11-point gain on a resolution. So historically, we've run around a three and a half, four point gain on our resolutions of NPL loans, and we had an 11-point gain for Q2. In Q2, we did sell a couple large REOs that probably brought in about a $1 million gain, and if you look at the resolution activity at the long-term loan side up in the top, you see paid in full for Q2 was up $17 million UPB paid in full for a $3.3 million gain, where for Q2 of last year, it was $21 million, but even both smaller gain. The reason that's happening is some of those loans that were in foreclosure in the judicial states where it takes about a year and a half to two years to settle those loans. Some of those are finally coming through. And remember, we've got that four-point default interest tacked on, and that's accruing the whole time it's a foreclosure process. So as these borrowers are now paying off those loans because we're getting to a point where we can foreclose on the properties, and they don't want to lose the property. So as they're paying off these loans, they have to pay it off, and they have to come up with all that default interest too. And that's why you’re seeing a lot of those significant gains coming through. With the growth in production, growth in the in-place portfolio and maintaining that spread, we're seeing great core diluted earnings per share. You saw it was $0.31 for Q2. Year-to-date, our core diluted EPS is $0.67 a share versus $0.45 a share for the first six months of '21. So year-over-year, we've seen a 50% increase in that core diluted earnings per share. On the next slide, the loan investment portfolio performance. With all that strong resolutions that we're doing, the NPL rate continues to come down. We ended Q2 at an 8.2% nonperforming rate year-over-year comparison that compares to 15.3% where we're at Q2 of '21. Remember, at the end of 2020, we were as high as 17.1%. We feel very, very good about the way we've been able to get these loans performing again or to resolve the loans by having them pay down or pay current, all at the same time still making a four-point or even 11-point gain on those resolutions. In terms of our loan loss reserve or CECL reserve, it remains very consistent in terms of basis points of reserve on UPB. You see we were 19 basis points back in Q2 of '21. We kind of had additional reserves on there, not knowing the uncertainties of COVID, and now we're kind of evening out right around the 16 to 17 basis points. In total dollars, we ended the quarter at $4.9 million, which is a 5.2% increase from Q1 and a 24% increase from June of last year, and that's really as a result of just the growth of the portfolio. The key point is, on the right-hand side of the bottom, you see our charge-offs. Our charge-offs have been running consistently low, and that's historical too. If you look at the last four quarters, the average loan charge-offs have been about $168,000 a quarter with this most recent quarter, it's coming in at under $38,000. So again, strong resolutions, NPL rate coming down, very low charge-offs, very good gains in maintaining our margin in a widely moving interest rate environment. We feel very good about our results and where we're headed so far this year. On Page 11, a durable funding and liquidity strategy. Chris hit most of the high points there. We did four securitizations already in 2022. I think we did four all last year, and we brought on four during the first six months. Three of those securitizations were in Q2. We're having no problem getting the securitizations done in a moving market. We did $896 million worth of securitizations issued this year, of which $623 million almost was in Q2. We’ve seen a couple of things with these securitizations. One, we're able to collapse a couple of older deals. One deal was as far back as 2015. We're able to collapse that and re-securitize it in our pro rata structure and actually at lower cost. As it paid down, our equity just went up, because all the payments were going to bondholders, and we're able to deleverage that to a 75% advance rate and generate quite a bit of liquidity. So we ended the second quarter with about $134 million in available liquidity, $46 million of that being the cash that you see on the balance sheet and then another $88 million in loans that are unfinanced, that we can put on lines at any time and draw liquidity off of. We feel really good about our liquidity position ending the quarter. We raised the maximum capacity of our warehouse lending from $650 million to $750 million. There's a $100 million capacity, as we see production and the portfolio growing. So with that, I'll turn it back to Chris to go over the economic value of equity.

Chris Farrar, President and CEO

Thanks, Mark. Appreciate it. On Slide 12, we've shown this slide a few quarters in a row now, so I won't spend a tremendous amount of time on it. But want to make the point that most of our peers mark their balance sheet to fair value. If we were to do something like that, we'd see a much higher mark than what you see just looking at the face of the financial statements, and that's largely driven by the locked-in spread and embedded gain in the portfolio. We think from a value perspective, we're undervalued based on where our stock is trading today, and we want to highlight that we believe there's a lot of future value that's yet to be realized. On Slide 13, just kind of talking about the outlook. We mentioned that we are seeing good demand from a credit perspective, and we feel safe there. There has been a lot in the press about what's going to happen and what may happen. But so far, we think things are good and we expect it to continue that way. We do plan to do two more securitizations this year, and I think from an earnings perspective, we just want to continue to focus on managing the portfolio, providing that stable spread and looking for any opportunities to grow, both organically and strategically. So with that, we'll turn it back over to Andrew; we can see if there are any questions.

Operator, Operator

We will now begin the question-and-answer session. The first question comes from Arren Cyganovich with Citi. Please, go ahead.

Arren Cyganovich, Analyst

Thank you. On the production side, it was a solid quarter, though slightly lower. It seems you managed to pass on some of the price increases, which slowed production. What level of production do you anticipate in the second half of the year, and could you discuss how the production pace varied throughout the quarter?

Chris Farrar, President and CEO

Yes. Hi, Arren, good question. I think the right guidance is kind of with the second quarter level. We feel good that we're going to be able to deliver that for the next few quarters. So I think that's a good run rate.

Arren Cyganovich, Analyst

Okay. That's good. And then on the securitizations that you did recently, how have those been pricing relative to some of your earlier securitizations?

Chris Farrar, President and CEO

Yes. So they're definitely pricing a lot wider than certainly 2021. 2021 was a banner year for us, and we were getting some incredible pricing there. I would say, they’re pricing a little wider than even before 2021. So margins aren't as strong on the most recent deals as probably they have been historically. But I think on a go-forward basis, we feel like we've caught the pipeline up now. Obviously, it depends a lot on where the market goes from here, but we're feeling like we're back in line from a spread perspective now.

Arren Cyganovich, Analyst

And that would be kind of around that 4% type of NIM? That's the expectation?

Chris Farrar, President and CEO

Yes. That's right.

Operator, Operator

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

Steve DeLaney, Analyst

Thanks. Hey, guys, congrats on a really strong quarter, and obviously a very challenging market. Mark, congrats to you from another former public company CFO. It's a tight stuff work, so great job.

Mark Szczepaniak, CFO

Thank you.

Steve DeLaney, Analyst

Chris, you talked about the stress situations, seeing some things out there. Boy, we have seen some shops shut down. And just this morning, I saw a mortgage REIT write off over $20 million of a preferred equity investment in an originator who had ceased operations. So we know those kinds of things are out there. Just curious, as you look at those opportunities, is it a matter of just looking at loan collateral that may be sitting on warehouse somewhere or is there any interest in infrastructure, and any product expansion opportunities? Thanks.

Chris Farrar, President and CEO

Sure. Thanks, Steve. Appreciate it. Yes. So we've seen both asset opportunities and strategic opportunities. Nothing huge yet, but I feel like it's the beginning of a larger opportunity set. On the asset side, yes, I think you're largely seeing assets that are probably home either on a warehouse line or maybe have some scratch and dent characteristics or something like that, where we would obviously look to pick those up at a discount. And then I think strategically, we've seen a couple of platforms we've looked at; nothing compelling yet, and we haven't seen anything in terms of new products, but we're open to that. My gut tells me over the next six months, we may see something like that.

Steve DeLaney, Analyst

Okay, well, over the last year or so, it has been important to keep things organized on your end. However, you all have managed to get things in order and are in a strong position to capitalize on opportunities. I am curious about your current pricing; I assume it is probably close to eight, and I would like to know how demand looks at that pricing level.

Chris Farrar, President and CEO

Yes. So our more recent production is kind of in the 8.5% to 9% coupon range. And yes, in the last few weeks, submissions have been very strong. I think there's what I call kind of a sensitivity period where customers and client borrowers are adjusting to changes. There was a little bit of an adjustment period there for sure, but we’re very pleased to see how strong submissions have been.

Steve DeLaney, Analyst

Great. Thank you both for the comments. Appreciate it.

Chris Farrar, President and CEO

Thank you, Steve.

Operator, Operator

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

Chris Farrar, President and CEO

I just want to say thanks again for everybody for participating and all of your support, and we're grateful for the years of support that we've seen from everyone. So that will conclude our call. Thank you.

Mark Szczepaniak, CFO

Thank you.

Operator, Operator

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