10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2020

OR

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______ to _____

Commission File Number: 001-39183

Velocity Financial, Inc.

(Exact Name of Registrant as Specified in its Charter)

Delaware	46-0659719
( State or other jurisdiction of<br><br><br>incorporation or organization)	(I.R.S. Employer<br>Identification No.)
30699 Russell Ranch Road, Suite 295<br><br><br>Westlake Village, California	91362
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number, including area code: (818) 532-3700

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Trading<br><br><br>Symbol(s)	Name of each exchange on which registered
Common stock, par value $0.01 per share	VEL	The New York Stock Exchange

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).     Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	☐	Accelerated filer	☐
Non-accelerated filer	☒	Smaller reporting company	☒
Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes  ☐    No  ☒

As of October 30, 2020, the registrant had 20,087,494 shares of common stock, $0.01par value per share, outstanding.

Table of Contents

		Page
PART I.	FINANCIAL INFORMATION
Item 1.	Consolidated Financial Statements (Unaudited)	2
	Consolidated Balance Sheets	2
	Consolidated Statements of Income	3
	Consolidated Statements of Changes in Stockholders’/ Members’ Equity	4
	Consolidated Statements of Cash Flows	5
	Notes to Unaudited Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	28
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	51
Item 4.	Controls and Procedures	51
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	52
Item 1A.	Risk Factors	52
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	52
Item 3.	Defaults Upon Senior Securities	52
Item 4.	Mine Safety Disclosures	52
Item 5.	Other Information	52
Item 6.	Exhibits	53
SIGNATURES		54

i

Item 1. Consolidated Financial Statements (Unaudited)

VELOCITY FINANCIAL, INC.

(FORMERLY KNOWN AS VELOCITY FINANCIAL, LLC AND SUBSIDIARIES)

CONSOLIDATED BALANCE SHEETS

($ in thousands, except par value amounts)

		December 31, 2019
ASSETS
Cash and cash equivalents	19,210	$	21,465
Restricted cash	7,821		6,087
Loans held for sale, net	—		214,467
Loans held for investment, net	2,001,086		1,863,360
Loans held for investment, at fair value	3,327		2,960
Total loans, net	2,004,413		2,080,787
Accrued interest receivables	13,134		13,295
Receivables due from servicers	44,466		49,659
Other receivables	402		4,778
Real estate owned, net	14,653		13,068
Property and equipment, net	4,446		4,680
Net deferred tax asset	1,832		8,280
Other assets	16,489		12,667
Total assets	2,126,866	$	2,214,766
LIABILITIES
Accounts payable and accrued expenses	61,859	$	56,146
Secured financing, net	74,776		145,599
Securitizations, net	1,670,930		1,438,629
Warehouse and repurchase facilities, net	19,541		421,548
Total liabilities	1,827,106		2,061,922
Commitments and contingencies
MEZZANINE EQUITY
Series A Convertible preferred stock (45,000 shares designated, 0.01 par value; 45,000<br>   shares issued and outstanding)	90,000		—
STOCKHOLDERS' / MEMBERS' EQUITY
Preferred stock (0.01 par value, 25,000,000 shares authorized; 45,000 issued and<br>   outstanding as reflected in Mezzanine Equity)	—		—
Common stock (0.01 par value, 100,000,000 shares authorized; 20,087,494 shares issued<br>   and outstanding at September 30, 2020, none issued and outstanding at December 31, 2019)	201		—
Additional paid-in capital	203,937		—
Retained earnings	5,622		—
Members’ equity (at December 31, 2019)	—		152,844
Total stockholders' / members’ equity	209,760		152,844
Total liabilities, mezzanine equity and stockholders' / members’ equity	2,126,866	$	2,214,766

All values are in US Dollars.

See accompanying Notes to Consolidated Financial Statements.

VELOCITY FINANCIAL, INC.

(FORMERLY KNOWN AS VELOCITY FINANCIAL, LLC AND SUBSIDIARIES)

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share amounts)

(Unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2020			2019			2020			2019
Interest income	$	41,374		$	40,379		$	125,766		$	113,407
Interest expense — portfolio related		22,347			21,827			66,384			61,214
Net interest income — portfolio related		19,027			18,552			59,382			52,193
Interest expense — corporate debt		1,913			3,842			10,149			10,548
Net interest income		17,114			14,710			49,233			41,645
Provision for loan losses		1,573			338			4,662			898
Net interest income after provision for loan losses		15,541			14,372			44,571			40,747
Other operating income
Gain (loss) on disposition of loans		(51	)		56			2,721			2,914
Unrealized gain (loss) on fair value loans		379			(18	)		411			(51	)
Other income (expense)		1,021			(250	)		(1,504	)		(1,046	)
Total other operating (expense) income		1,349			(212	)		1,628			1,817
Operating expenses
Compensation and employee benefits		5,692			3,712			16,595			11,519
Rent and occupancy		415			369			1,319			1,105
Loan servicing		2,168			1,957			5,825			5,457
Professional fees		1,051			398			2,823			1,587
Real estate owned, net		898			485			2,439			1,348
Other operating expenses		1,641			1,563			5,822			4,292
Total operating expenses		11,865			8,484			34,823			25,308
Income before income taxes		5,025			5,676			11,376			17,256
Income tax expense		1,544			1,796			3,175			5,146
Net income	$	3,481		$	3,880		$	8,201		$	12,110
Less deemed dividends on preferred stock	$	—		NA			$	48,955		NA
Net income (loss) allocated to common shareholders	$	3,481		NA			$	(40,754	)	NA
Earnings (loss) per common share
Basic	$	0.17		NA			$	(2.03	)	NA
Diluted	$	0.11		NA			$	(2.03	)	NA
Weighted average common shares outstanding
Basic		20,087		NA				20,087		NA
Diluted		32,435		NA				20,087		NA

See accompanying Notes to Consolidated Financial Statements.

VELOCITY FINANCIAL, INC.

(FORMERLY KNOWN AS VELOCITY FINANCIAL, LLC AND SUBSIDIARIES)

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ / MEMBERS' EQUITY

($ in thousands)

(Unaudited)

				Common Stock
	Members’<br><br><br>Equity			Shares		Par Value		Additional<br><br><br>Paid-in<br><br><br>Capital			Retained<br><br><br>Earnings			Total<br><br><br>Stockholders'<br><br><br>Equity
Balance – December 31, 2018	$	136,800			—	$	—	$	—		$	—		$	—
Liquidation preference return, Class C		(463	)		—		—		—			—			—
Net income		4,695			—		—		—			—			—
Balance – March 31, 2019	$	141,032			—		—		—			—			—
Liquidation preference return, Class C		(471	)		—		—		—			—			—
Net income		3,535			—		—		—			—			—
Balance – June 30, 2019	$	144,096			—		—		—			—			—
Liquidation preference return, Class C		(315	)		—		—		—			—			—
Net income		3,880			—		—		—			—			—
Balance – September 30, 2019	$	147,661			—		—		—			—			—
Balance – December 31, 2019	$	152,844			—	$	—	$	—		$	—		$	152,844
Cumulative effect of change in accounting principle (1)		—			—		—		—			(96	)		(96	)
Balance - January 1, 2020	$	152,844			—	$	—	$	—		$	(96	)	$	152,748
Class A equity units conversion		(92,650	)		—		—		—			—			(92,650	)
Class D equity units conversion		(60,194	)		—		—		—			—			(60,194	)
Issuance of common stock		—			20,087,494		201		247,539			—			247,740
Stock-based compensation		—			—		—		207			—			207
Net income		—			—		—		—			2,579			2,579
Balance – March 31, 2020	$	—			20,087,494	$	201	$	247,746		$	2,483		$	250,430
Deemed dividends-convertible preferred stock		—			—		—		(46,472	)		(2,483	)		(48,955	)
Issuance of warrants		—			—		—		2,158			—			2,158
Stock-based compensation		—			—		—		253			—			253
Net income		—			—		—		—			2,141			2,141
Balance – June 30, 2020	$	—			20,087,494	$	201	$	203,685		$	2,141		$	206,027
Stock-based compensation		—			—		—		252			—			252
Net income		—			—		—		—			3,481			3,481
Balance – September 30, 2020	$	—			20,087,494	$	201	$	203,937		$	5,622		$	209,760
(1)	Impact due to adoption of ASU 2016-13, "Measurement of Credit Losses on Financial Instruments", and related amendments on January 1, 2020.
---	---

See accompanying Notes to Consolidated Financial Statements.

VELOCITY FINANCIAL, INC.

(FORMERLY KNOWN AS VELOCITY FINANCIAL, LLC AND SUBSIDIARIES)

CONSOLIDATED STATEMENTS OF CASH FLOWS

($ in thousands)

	Nine Months Ended September 30,
	2020			2019
	(Unaudited)
Cash flows from operating activities:
Net income	$	8,201		$	12,110
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		918			1,004
Amortization of right-of-use assets		916			772
Provision for loan losses		4,662			898
Origination of loans held for sale		(96,064	)		(214,370	)
Proceeds from sales of loans held for sale		80,858			114,046
Purchase of held for sale loans		(1,232	)		—
Repayments on loans held for sale		19,850			11,162
Net accretion of discount on purchased loans and deferred loan origination costs		3,288			3,393
Provision for uncollectible borrower advances		518			49
Gain on disposition of loans		(2,209	)		(2,749	)
Real estate acquired through foreclosure in excess of recorded investment		(511	)		(165	)
Amortization of debt issuance discount and costs		12,807			7,695
Loss on disposal of property and equipment		41			7
Change in valuation of real estate owned		1,744			572
Change in valuation of fair value loans		(411	)		51
Change in valuation of held for sale loans		(345	)		(84	)
Gain on sale of real estate owned		(652	)		(211	)
Stock-based compensation		712			—
Net deferred tax expense (benefit)		6,489			(3,611	)
(Increase) decrease in operating assets and liabilities:
Accrued interest and other receivables		(5,549	)		(6,277	)
Other assets		(5,112	)		(13,511	)
Accounts payable and accrued expenses		8,445			12,026
Net cash provided by (used in) operating activities		37,364			(77,193	)
Cash flows from investing activities:
Purchase of loans held for investment		(3,571	)		(9,276	)
Origination of loans held for investment		(161,797	)		(482,475	)
Payoffs of loans held for investment and loans at fair value		242,166			268,671
Proceeds from sale of real estate owned		5,867			3,028
Capitalized real estate owned improvements		(598	)		(1,122	)
Change in advances		(5,272	)		(614	)
Change in impounds and deposits		(2,732	)		3,132
Purchase of property and equipment		(724	)		(378	)
Net cash provided by (used in) investing activities		73,339			(219,034	)
Cash flows from financing activities:
Warehouse repurchase facilities advances		267,539			650,331
Warehouse repurchase facilities repayments		(670,404	)		(517,197	)
Proceeds from secured financing		—			153,000
Repayment of secured financing		(75,000	)		(127,594	)
Proceeds of securitizations, net		517,995			444,105
Repayment of securitizations		(284,901	)		(268,547	)
Debt issuance costs		(8,552	)		(14,833	)
Repurchase of Class C preferred units		—			(27,714	)
Net proceeds from issuance of preferred stock		41,044			—
Proceeds from issuance of warrants		2,158			—
Issuance of common stock		100,800			—
IPO deal costs		(1,903	)		—
Net cash (used in) provided by financing activities		(111,224	)		291,551
Net decrease in cash, cash equivalents, and restricted cash		(521	)		(4,676	)
Cash, cash equivalents, and restricted cash at beginning of period		27,552			16,677
Cash, cash equivalents, and restricted cash at end of period	$	27,031		$	12,001

See accompanying Notes to Consolidated Financial Statements.

VELOCITY FINANCIAL, INC.

(FORMERLY KNOWN AS VELOCITY FINANCIAL, LLC AND SUBSIDIARIES)

CONSOLIDATED STATEMENTS OF CASH FLOWS

($ in thousands)

	Nine Months Ended September 30,
	2020			2019
	(Unaudited)
Supplemental cash flow information:
Cash paid during the period for interest	$	63,516		$	61,846
Cash paid during the period for income taxes		2,861			14,073
Noncash transactions from investing and financing activities:
Transfer of loans held for investment to real estate owned		7,435			10,741
Transfer of accrued interest to loans held for investment		6,574			—
Transfer of loans held for sale to held for investment		213,609			—
Return paid-in-kind on Class C preferred units		—			1,249
Return paid-in-kind on Class D preferred units		—			10,340
Deferred IPO costs charged against additional paid-in capital		(4,000	)		—
Discount (premium) on issuance of securitizations					67

See accompanying Notes to Consolidated Financial Statements

VELOCITY FINANCIAL, INC. AND SUBSIDIARIES

(FORMERLY KNOWN AS VELOCITY FINANCIAL, LLC AND SUBSIDIARIES)

Notes to Consolidated Financial Statements (Unaudited)

Note 1 — Organization and Description of Business

Velocity Financial, LLC (VF or the Company) was a Delaware limited liability company formed on July 9, 2012 for the purpose of acquiring all membership units in Velocity Commercial Capital, LLC (VCC). On January 16, 2020, Velocity Financial, LLC converted from a Delaware limited liability company to a Delaware corporation and changed its name to Velocity Financial, Inc. Upon completion of the conversion, Velocity Financial, LLC’s Class A equity units of 97,513,533 and Class D equity units of 60,193,989 were converted to 11,749,994 shares of Velocity Financial, Inc. common stock. On January 22, 2020, the Company completed its initial public offering of 7,250,000 shares of common stock at a price to the public of $13.00 per share. On January 28, 2020, the Company completed the sale of an additional 1,087,500 shares of its common stock, representing the full exercise of the underwriters’ option to purchase additional shares, at a public offering price of $13.00 per share. The Company’s stock trades on The New York Stock Exchange under the symbol “VEL”.

VCC, a California LLC formed on June 2, 2004, is a mortgage lender that originates and acquires small balance investor real estate loans, providing capital to the investor real estate loan market. The Company is licensed as a California Finance Lender and, as such, is required to maintain a minimum net worth of $250 thousand. The Company does not believe there is any potential risk of not being able to meet this regulatory requirement. The Company uses its equity capital and borrowed funds to originate and invest in investor real estate loans and seeks to generate income based on the difference between the yield on its investor real estate loan portfolio and the cost of its borrowings. The Company does not engage in any other significant line of business or offer any other products or services, nor does it originate or acquire investments outside of the United States of America.

The Company, through its wholly owned subsidiaries, is the sole beneficial owner of the Velocity Commercial Capital Loan Trusts, from the 2014-1 Trust through and including the 2020-MC1 Trust, all of which are New York common law trusts. The Trusts are bankruptcy remote, variable interest entities (VIE) formed for the purpose of providing secured borrowings to the Company and are consolidated with the accounts of the Company.

Note 2 — Basis of Presentation and Summary of Significant Accounting Policies

The consolidated financial statements of the Company have been prepared on the accrual basis of accounting and in accordance with United States Generally Accepted Accounting Principles (U.S. GAAP).

(a)	Partnership to Corporation Conversion

On January 16, 2020, Velocity Financial, LLC converted from a limited liability company to a corporation and changed its name to Velocity Financial, Inc. The Conversion was accounted for in accordance with ASC 805-50 –Business Combinations, as a transaction between entities under common control. All assets and liabilities of Velocity Financial, LLC were contributed to Velocity Financial, Inc. at their carrying value, and the results of operations are being presented as if the Conversion had occurred on January 1, 2020. Additionally, Class A and Class D’s partnership equity at December 31, 2019 were converted to stockholders’ equity and presented as such on the Consolidated Balance Sheets and the Consolidated Statement of Changes in Stockholders’ Equity effective January 1, 2020.

(b)	Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosures of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of consolidated income and expenses during the reporting period.

(c)	Significant Accounting Policies

The Company’s significant accounting policies are described in Note 2 — Basis of Presentation and Summary of Significant Accounting Policies, of its audited consolidated financial statements included in its Annual Report on Form 10-K for the year ended December 31, 2019 as filed with the Securities and Exchange Commission ("Form 10-K").

There have been no significant changes to the Company’s significant accounting policies as described in its 2019 Annual Report other than the adoption of ASU 2016-13 Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments as described in Note 3 — Current Accounting Developments.

(d)	Principles of Consolidation

The principles of consolidation require management to determine and reassess the requirement to consolidate VIEs each reporting period, and therefore, the determination may change based on new facts and circumstances pertaining to each VIE. This could result in a material impact to the Company’s consolidated financial statements in subsequent reporting periods.

The Company consolidates the assets, liabilities, and remainder interests of the Trusts as management determined that VCC is the primary beneficiary of these entities. The Company’s ongoing asset management responsibilities provide the Company with the power to direct the activities that most significantly impact the VIE’s economic performance, and the remainder interests provide the Company with the right to receive benefits and the obligation to absorb losses, limited to its investment in the remainder interest of the Trusts.

The following table presents a summary of the assets and liabilities of the Trusts as of September 30, 2020 and December 31, 2019.  Intercompany balances have been eliminated for purposes of this presentation (in thousands):

	September 30, 2020		December 31, 2019
Restricted cash	$	7,278	$	—
Loans held for investment, net		2,000,787		1,571,100
Accrued interest and other receivables		57,615		56,675
Real estate owned, net		8,832		6,091
Other assets		4		11
Total assets	$	2,074,516	$	1,633,877
Accounts payable and accrued expenses	$	41,932	$	21,265
Securities issued		1,670,930		1,438,629
Total liabilities	$	1,712,862	$	1,459,894

The consolidated financial statements as of September 30, 2020 and December 31, 2019 include only those assets, liabilities, and results of operations related to the business of the Company, its subsidiaries, and VIEs, and do not include any assets, liabilities, revenues, and expenses attributable to limited liability members’ individual activities. The liability of each member in an LLC was limited to the amounts reflected in their respective member accounts.

Note 3 — Current Accounting Developments

Accounting Standards Adopted in 2019

Effective January 1, 2020, the Company adopted ASU 2016-13 Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments using the open pool methodology for all financial assets measured at amortized cost, which as of the adoption date consisted of the Company’s held for investment loan portfolio, excluding loans held for investment measured at fair value.

ASU 2016-13 replaces the incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (CECL) methodology. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loan receivables held for investment. Under the CECL methodology, the allowance for credit losses is measured on a collective (pool) basis when similar risk characteristics exist. The Company has identified the following portfolio segments based on risk characteristics of the loans in its loan portfolio (pool):

•	Residential 1– 4 Unit – Purchase (loans to purchase 1– 4 unit residential rental properties);
•	Residential 1– 4 Unit – Refinance (refinance loans on 1– 4 unit residential rental properties);
---	---
•	Commercial – Purchase (loans to purchase traditional commercial properties) and
---	---
•	Commercial – Refinance (refinance loans on traditional commercial properties).
---	---

The Company determines the collectability of its loans by evaluating certain risk characteristics. The segmentation of its loan portfolio was determined based on analyses of the Company’s loan portfolio performance over the past seven years. Based on analyses of the loan portfolio’s historical performance, the Company concluded that loan purpose and product types are the most significant risk factors in determining its expectation of future loan losses. Loan purpose considers whether a borrower is acquiring the property or refinancing an existing property. The Company’s historical experience shows that refinance loans have higher loss rates than acquisitions. Product type includes residential 1-4 unit property and traditional commercial property. The Company’s historical experience shows that traditional commercial property loans have higher loss rates than residential 1-4 unit property.

To determine the loss rates used for the open pool methodology, the Company starts with its historical database of losses, segments the loans by loan purpose and product type, and then adjusts the loss rates based upon macroeconomic forecasts over a reasonable and supportable period. The reasonable and supportable period is meant to represent the period in which the Company believes the forecasted macroeconomic variables can be reasonably estimated.

In determining the January 1, 2020 CECL transition impact, the Company used a third-party model with a four-quarter reasonable and supportable forecast period followed by a four-quarter straight-line reversion period.  Management determined that a four-quarter forecast period and four-quarter straight-line reversion period were appropriate for the January 1, 2020 initial CECL estimate because, as of the beginning of the year, the economy was strong, unemployment and interest rates were low, and GDP was expected to have a modest increase during 2020.  Management concluded that using a 1-year forecast trending steadily back to the Company’s historical loss levels best fit the strong, stable economy at that time.

For the March 31, 2020 CECL estimate, the Company used a COVID-19 stress scenario with a six-quarter reasonable and supportable forecast period followed by a three-quarter straight-line reversion period. Management concluded that using a six-quarter forecast and a three-quarter straight-line reversion best coincided with management and analysts’ sentiments that the impact of the COVID crisis would linger into 2021, with expectation of a quick recovery. This forecast period and reversion to historical loss is subject to change as conditions in the market change and the Company’s ability to forecast economic events evolves.

For the June 30, 2020 CECL estimate, the Company used a COVID-19 stress scenario with a five-quarter reasonable and supportable forecast period followed by a four-quarter straight-line reversion period. Management concluded that the original six-quarter COVID-19 stress forecast was still appropriate and, therefore, used five remaining forecasted quarters as of June 30, 2020.  Given the second wave of the COVID pandemic, management decided to extend its reversion period by a quarter and used a four-quarter reversion period as of June 30, 2020.  This forecast period and reversion to historical loss is subject to change as conditions in the market change and the Company’s ability to forecast economic events evolves.

For the September 30, 2020 CECL estimate, the Company used a COVID-19 stress scenario with a five-quarter reasonable and supportable forecast period followed by a four-quarter straight-line reversion period. Management concluded that using the same forecast and reversion periods as last quarter was still appropriate given the extended COVID-19 pandemic and prolonged shutdowns.  This forecast period and reversion to historical loss is subject to change as conditions in the market change and the Company’s ability to forecast economic events evolves.

Loans 90 days or more delinquent and not included in our COVID-19 forbearance program, in bankruptcy, or in foreclosure, are evaluated individually for determination of allowance for credit losses. Loans individually evaluated are excluded from loans evaluated collectively by segment. The Company primarily relies on the value of the underlying real estate, coupled with low loan-to-value ratios, to satisfy the loan obligation, either through successful loss mitigation efforts or foreclosure and sale of the underlying real estate. Expected loan losses are based on the fair value of the collateral underlying the loans at the reporting date, adjusted for estimated selling costs as appropriate.

The allowance for credit losses is a valuation account that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on the loans. Loans are charged off against the allowance when the Company believes the uncollectibility of a loan balance is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off.

The Company estimates the allowance using relevant available information, from internal and external sources, relating to historical performance, current conditions, and reasonable and supportable macroeconomic forecasts. Historical credit loss experience provides the basis for the estimation of expected credit losses.  Adjustments to historical loss information are considered for differences in current loan-specific risk characteristics such as differences in underwriting standards, portfolio mix, delinquency levels, or term, as well as for changes in environmental conditions, such as unemployment rates, property values and changes in the competitive or regulatory environment.

The allowance for credit losses is maintained at a level deemed adequate by management to provide for expected losses in the portfolio at the balance sheet date. While management uses available information to estimate its required allowance for credit losses, future additions to the allowance for credit losses may be necessary based on changes in estimates resulting from economic and other conditions.

Interest income on loans held for investment is accrued on the unpaid principal balance (UPB) at their respective stated interest rates. Generally, loans are placed on nonaccrual status when they become 90 days past due. Loans are considered past due when contractually required principal or interest payments have not been made on the due dates.  Management has concluded that ASC 310-20-35-18(a) on interest income recognition does not apply to the forbearances granted under the Company’s COVID-19 forbearance program.  The Company will continue to accrue interest on the COVID-19 forbearance granted loans for all such loans that were less than 90 days past due at the forbearance grant date.  The Company will continue to evaluate the COVID-19 forbearance-granted loans on an individual basis to determine if a reserve should be established on the collectability of the accrued interest and whether any

loans should be placed on nonaccrual status at a future date. As of September 30, 2020, approximately $335.1 million or 81% of the $411.2 million loans granted a COVID-19 forbearance were subsequently brought current and the related accrued interest was added to the principal balances of the loans to be repaid by the borrowers upon the earlier of loan payoff or loan maturity. The deferred loans are considered current at the time of deferral, and the Company continues to accrue interest on the loans.

The Company has made the accounting policy election not to measure an allowance for credit losses for accrued interest receivables. When a loan is placed on nonaccrual status, the accrued and unpaid interest is reversed as a reduction of interest income and accrued interest receivable. Accrued interest receivable is excluded from the amortized cost of loans and it is presented as accrued interest receivable in the Consolidated Balance Sheets.

The Company adopted ASU 2016-13, or ASU 326 using the modified-retrospective transition approach. Upon adoption, the Company recognized a cumulative effect adjustment to decrease retained earnings by $96,000, net of taxes. Results for reporting periods after January 1, 2020 are presented under ASC 326, while prior period amounts continue to be reported in accordance with previously applicable GAAP.

The following table illustrates the impact of ASC 326 on the Company’s allowance for credit losses (in thousands):

	January 1, 2020
	As Reported				Impact of
	Under		Pre-ASC 326		ASC 326
Allowance for credit losses	ASC 326		Adoption		Adoption
Commercial - Purchase	$	323	$	304	$	19
Commercial - Refinance		1,078		1,016		62
Residential 1-4 Unit - Purchase		157		148		9
Residential 1-4 Unit - Refinance		819		772		47
Total	$	2,377	$	2,240	$	137

Recent Regulatory and Legislative Developments

On March 27, 2020, President Trump signed into law the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), which, among other things, allows the Company to (i) elect to suspend the requirements under GAAP for loan modifications related to COVID-19 that would otherwise be categorized as troubled debt restructurings (TDRs), and (ii) suspend any determination of a loan modified as a result of the effects of COVID-19 as being a TDR, including impairment for accounting purposes.

On March 22, 2020, the federal banking agencies issued an interagency statement to provide additional guidance to financial institutions who are working with borrowers affected by COVID-19. The agencies have confirmed with staff of the Financial Accounting Standards Board that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief, are not TDRs. This includes short-term (e.g., six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented.

In response to the COVID-19 pandemic, the Company has implemented a COVID-19 forbearance program allowing customers to primarily defer payments for up to 90 days. Deferrals under the CARES Act or interagency guidance are not considered troubled debt restructurings. Interest on loans in the COVID-19 forbearance program that were less than 90 days past due at forbearance grant date or contractually became 90 days past due during the forbearance period continued to accrue through the forbearance period.  Approximately $335.1 million or 81% of the $411.2 million loans granted a COVID-19 forbearance were subsequently brought current and the related accrued interest was added to the principal balances of the loans to be repaid by the borrowers upon the earlier of loan payoff or loan maturity.

Note 4 — Cash, Cash Equivalents, and Restricted Cash

The Company is required to hold cash for potential future advances due to certain borrowers. The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the Company’s consolidated statement of financial condition that sum to the total of the same such amounts shown in the consolidated statements of cash flows for the nine months ended September 30, 2020 and 2019 (in thousands):

	Nine Months Ended September 30,
	2020		2019
Cash and cash equivalents	$	19,210	$	8,849
Restricted cash		7,821		3,152
Total cash, cash equivalents, and restricted cash shown in the statement of cash flows	$	27,031	$	12,001

Note 5 — Loans Held for Sale, Net

The following table summarizes loans held for sale as of September 30, 2020 and December 31, 2019 (in thousands):

	September 30, 2020		December 31, 2019
Unpaid principal balance	$	—	$	216,054
Valuation adjustments		—		(396	)
Deferred loan origination costs		—		(1,191	)
Ending balance	$	—	$	214,467

Effective July 1, 2020, the loans held for sale portfolio with unpaid principal balance of $214.4 million were transferred to the held for investment loan portfolio. The related valuation allowance of $1.3 million on these loans were reversed through earnings and included in “Other income” in the consolidated statements of income.

Note 6 — Loans Held for Investment and Loans Held for Investment at Fair Value

The following tables summarize loans held for investment as of September 30, 2020 and December 31, 2019 (in thousands):

	September 30, 2020									December 31, 2019
	Loans held for investment, net			Loans held for investment, at fair value			Total loans held for investment			Total loans held for investment
Unpaid principal balance	$	1,982,984		$	3,360		$	1,986,344		$	1,843,290
Valuation adjustments on FVO loans		—			(33	)		(33	)		(444	)
Deferred loan origination costs		23,850			—			23,850			25,714
		2,006,834			3,327			2,010,161			1,868,560
Allowance for loan losses		(5,748	)		—			(5,748	)		(2,240	)
Total loans held for investment and loans held for investment at<br><br><br>fair value, net	$	2,001,086		$	3,327		$	2,004,413		$	1,866,320

As of September 30, 2020, $411.2 million in UPB with a $416.2 million amortized costs basis of loans held for investment have participated in the COVID-19 forbearance program. Accrued interest on these loans was $24.8 million as of September 30, 2020. Approximately $335.1 million or 81% of the $411.2 million loans granted a COVID-19 forbearance were subsequently brought current and the related accrued interest was added to the principal balances of the loans to be repaid by the borrowers upon the earlier of loan payoff or loan maturity.

As of September 30, 2020 and December 31, 2019, the gross unpaid principal balance of loans held for investment pledged as collateral for the Company’s warehouse facility agreements, and securitizations issued were as follows (in thousands):

	September 30, 2020		December 31, 2019
The 2013 repurchase agreement	$	8,094	$	108,504
The 2015 repurchase agreement		—		175,689
The Bank credit agreement		—		3,331
Total pledged loans	$	8,094	$	287,524
2014-1 Trust		25,066		29,559
2015-1 Trust		55,032		64,876
2016-1 Trust		78,125		97,727
2016-2 Trust		52,430		68,961
2017-1 Trust		89,888		116,670
2017-2 Trust		150,330		173,390
2018-1 Trust		122,763		141,567
2018-2 Trust		230,982		260,278
2019-1 Trust		215,248		229,151
2019-2 Trust		184,820		210,312
2019-3 Trust		142,646		157,119
2020-1 Trust		252,406		—
2020-2 Trust		126,694		—
2020-MC1 Trust		250,644		—
Total	$	1,977,074	$	1,549,610
(a)	Nonaccrual Loans
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The following tables present the amortized cost basis, or recorded investment, of the Company’s loans held for investment that were nonperforming and on nonaccrual status as of September 30, 2020 and December 31, 2019, and accruing loans that were 90 days or more past due as of September 30, 2020 under the Company’s COVID-19 payment forbearance programs. There were no loans accruing interest that were greater than 90 days past due as of December 31, 2019.

	September 30, 2020
	Nonaccrual With				Loans 90+ DPD
	No Allowance		Total		Still Accruing
	for Loan Loss		Nonaccrual		COVID-19 Program
	(In thousands)
Commercial - Purchase	$	19,201	$	20,544	$	1,222
Commercial - Refinance		97,846		102,336		4,026
Residential 1-4 Unit - Purchase		26,206		27,800		2,662
Residential 1-4 Unit - Refinance		150,275		165,434		6,871
Total	$	293,528	$	316,114	$	14,781
Troubled Debt Restructuring included in nonaccrual loans:	$	—	$	175	$	—
	December 31, 2019
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	( in thousands)
Nonaccrual loans:
Recorded investment
Percentage of the originated loans held for investment		%
Impaired loans:
Unpaid principal balance
Recorded investment
Recorded investment of impaired loans requiring a specific allowance
Specific allowance
Specific allowance as a percentage of recorded investment of impaired loans requiring a<br><br><br>specific allowance		%
Recorded investment of impaired loans not requiring a specific allowance
Percentage of recorded investment of impaired loans not requiring a specific allowance		%
TDRs included in impaired loans:
Recorded investment of TDRs
Recorded investment of TDRs with a specific allowance
Specific allowance
Recorded investment of TDRs without a specific allowance

All values are in US Dollars.

The Company has made the accounting policy election not to measure an allowance for credit losses for accrued interest receivables. The Company has also made the accounting policy election to write off accrued interest receivables by reversing interest income when loans are placed on nonaccrual status, or 90 days or more past due, other than the COVID-19 forbearance-granted loans. The Company will continue to evaluate the COVID-19 forbearance-granted loans on an individual basis to determine if a reserve should be established on the collectability of the accrued interest and whether any loans should be placed on nonaccrual status at a future date. The following table presents the amortized cost basis in the loans held for investment as of September 30, 2020 and 2019, and the amount of accrued interest receivables written off by reversing interest income by portfolio segment for the nine months ended September 30, 2020 and 2019 (in thousands):

	September 30, 2020				September 30, 2019
	Amortized Cost		Interest Reversal		Amortized Cost		Interest Reversal
Commercial - Purchase	$	293,886	$	576	$	272,344	$	219
Commercial - Refinance		695,664		3,092		672,877		990
Residential 1-4 Unit - Purchase		282,212		724		243,972		210
Residential 1-4 Unit - Refinance		735,072		4,156		588,725		894
Total	$	2,006,834	$	8,548	$	1,777,918	$	2,313

Any future payments received for these loans will be recognized on a cash basis.

For the nine months ended September 30, 2020 and 2019, cash basis interest income recognized on nonaccrual loans was $11.6 million and $8.7 million, respectively, and there was no accrued interest income recognized on nonaccrual loans. The average recorded investment of individually evaluated loans, computed using month-end balances, was $223.7 million and $106.3 million for nine months ended September 30, 2020 and 2019, respectively. There were no commitments to lend additional funds to debtors whose loans have been modified as of September 30, 2020 and December 31, 2019.

(b)	Allowance for Credit Losses

The following tables present the activity in the allowance for credit losses for the three and nine months ended September 30, 2020 and 2019 (in thousands):

	Three Months Ended September 30,
	2020															2019
							Residential			Residential
	Commercial			Commercial			1-4 Unit			1-4 Unit
	Purchase			Refinance			Purchase			Refinance			Total			Total
Allowance for credit losses:
Beginning balance	$	524		$	2,687		$	403		$	1,607		$	5,221		$	2,096
Provision for loan losses (1)		(90	)		(101	)		171			1,593			1,573			338
Charge-offs		—			(210	)		(37	)		(799	)		(1,046	)		(323	)
Ending balance	$	434		$	2,376		$	537		$	2,401		$	5,748		$	2,111
(1)	The provision for loans losses would have been approximately $0.4 million for the three months ended September 30, 2020, excluding the $1.2 million impact from the loans held for sale transferred to loans held for investment. The additional $1.2 million provision was mainly offset by the reversal of the $1.3 million valuation allowance on the held for sale loans, which was recorded to “Other income” in the consolidated statements of income.
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	Nine Months Ended September 30,
---	---	---	---	---	---	---	---	---	---	---	---	---	---	---	---	---	---	---
	2020															2019
							Residential			Residential
	Commercial			Commercial			1-4 Unit			1-4 Unit
	Purchase			Refinance			Purchase			Refinance			Total			Total
Allowance for credit losses:
Beginning balance, prior to adoption of ASC 326	$	304		$	1,016		$	148		$	772		$	2,240		$	1,680
Impact of adopting ASC 326		19			62			9			47			137			—
Balance - January 1, 2020	$	323		$	1,078		$	157		$	819		$	2,377
Provision for loan losses (1)		190			1,508			553			2,411			4,662			898
Charge-offs		(79	)		(210	)		(173	)		(829	)		(1,291	)		(467	)
Ending balance	$	434		$	2,376		$	537		$	2,401		$	5,748		$	2,111
Allowance related to:
Loans individually evaluated	$	179		$	549		$	266		$	1,389		$	2,383		$	739
Loans collectively evaluated		255			1,828			271			1,011			3,365			1,372
Amortized cost related to:
Loans individually evaluated	$	20,544		$	102,337		$	27,800		$	165,434		$	316,115		$	110,134
Loans collectively evaluated		273,342			593,327			254,412			569,638			1,690,719			1,667,784
(1)	The provision for loans losses would have been approximately $3.5 million for the nine months ended September 30, 2020, excluding the $1.2 million impact from the loans held for sale transferred to loans held for investment. The additional $1.2 million provision was mainly offset by the reversal of the $1.3 million valuation allowance on the held for sale loans, which was recorded to “Other income” in the consolidated statements of income.
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(c)	Credit Quality Indicator
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A credit quality indicator is a statistic used by the Company to monitor and assess the credit quality of loans held for investment, excluding loans held for investment at fair value. The Company monitors its charge-off rate in relation to its nonperforming loans as its credit quality indicator. Nonperforming loans are loans that are 90 or more days past due, in bankruptcy, in foreclosure, or not accruing interest. As of September 30, 2020, the annualized charge-off rate was 0.55% of average nonperforming loans. The charged-off rate was 0.52% for the year ended December 31, 2019.

Other credit quality indicators include aging status and accrual status. The following table presents the aging status of the amortized cost basis in the loans held for investment portfolio, which includes $416.2 million loans in the Company’s COVID-19 forbearance program as of September 30, 2020, and as of December 31, 2019 (in thousands):

	30–59 days		60–89 days		90+days		Total				Total
September 30, 2020	past due		past due		past due^(1)^		past due		Current		loans
Loans individually evaluated
Commercial - Purchase	$	1,737	$	455	$	18,352	$	20,544	$	—	$	20,544
Commercial - Refinance		5,775		7,856		88,706		102,337				102,337
Residential 1-4 Unit - Purchase		519		—		27,281		27,800		—		27,800
Residential 1-4 Unit - Refinance		2,067		5,410		157,957		165,434		—		165,434
Total loans individually evaluated	$	10,098	$	13,721	$	292,296	$	316,115	$	—	$	316,115
Loans collectively evaluated
Commercial - Purchase	$	15,729	$	6,857	$	1,222	$	23,808	$	249,535	$	273,343
Commercial - Refinance		39,343		18,666		4,026		62,035		531,291		593,326
Residential 1-4 Unit - Purchase		11,582		27,962		2,662		42,206		212,207		254,413
Residential 1-4 Unit - Refinance		43,226		21,703		6,871		71,800		497,837		569,637
Total loans collectively evaluated	$	109,880	$	75,188	$	14,781	$	199,849	$	1,490,870	$	1,690,719
Ending balance	$	119,978	$	88,909	$	307,077	$	515,964	$	1,490,870	$	2,006,834
December 31, 2019:
Impaired loans	$	6,195	$	7,696	$	111,928	$	125,819	$	179	$	125,998
Nonimpaired loans		119,465		41,138		—		160,603		1,578,984		1,739,587
Ending balance	$	125,660	$	48,834	$	111,928	$	286,422	$	1,579,163	$	1,865,585
(1)	Includes loans in bankruptcy and foreclosure less than 90 days past due
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As of September 30, 2020, borrowers on approximately $308.3 million or 75% of the $411.2 million COVID-19 forbearance granted loans made their next scheduled payment. The following table presents the aging of the amortized cost basis of loans held for investment in the Company's COVID-19 forbearance program as of September 30, 2020 (in thousands):

	30–59 days		60–89 days		90+days		Total				Total
September 30, 2020	past due		past due		past due^(1)^		past due		Current		loans
Loans individually evaluated
Commercial - Purchase	$	—	$	—	$	2,533	$	2,533	$	—	$	2,533
Commercial - Refinance		—		—		13,793		13,793		—		13,793
Residential 1-4 Unit - Purchase		178		—		2,359		2,537		—		2,537
Residential 1-4 Unit - Refinance		—		431		16,143		16,574		—		16,574
Total loans individually evaluated	$	178	$	431	$	34,828	$	35,437	$	—	$	35,437
Loans collectively evaluated
Commercial - Purchase	$	8,079	$	6,253	$	1,222	$	15,554	$	34,053	$	49,607
Commercial - Refinance		18,456		10,383		4,026		32,865		105,132		137,997
Residential 1-4 Unit - Purchase		2,039		24,308		2,662		29,009		29,913		58,922
Residential 1-4 Unit - Refinance		14,620		12,281		6,871		33,772		100,505		134,277
Total loans collectively evaluated	$	43,194	$	53,225	$	14,781	$	111,200	$	269,603	$	380,803
Ending balance	$	43,372	$	53,656	$	49,609	$	146,637	$	269,603	$	416,240
(1)	Includes loans in bankruptcy and foreclosure less than 90 days past due. Also includes accruing loans 90+ day past due.
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In addition to the aging status, the Company also evaluates credit quality by accrual status. The following table presents the amortized cost in loans held for investment, excluding loans held for investment at fair value, based on accrual status and by loan origination year.

	Term Loans Amortized Cost Basis by Origination Year
September 30, 2020:	2020		2019		2018		2017		2016		Pre-2016		Total
Commercial - Purchase
Payment performance
Performing	$	35,424	$	104,154	$	67,331	$	41,042	$	11,409	$	13,982	$	273,342
Nonperforming		218		3,716		6,696		5,956		1,800		2,159		20,545
Total Commercial - Purchase	$	35,642	$	107,870	$	74,027	$	46,998	$	13,209	$	16,141	$	293,887
Commercial - Refinance
Payment performance
Performing	$	49,796	$	189,642	$	158,836	$	95,872	$	40,744	$	58,437	$	593,327
Nonperforming		3,309		23,191		38,192		20,757		7,330		9,557		102,336
Total Commercial - Refinance	$	53,105	$	212,833	$	197,028	$	116,629	$	48,074	$	67,994	$	695,663
Residential 1-4 Unit - Purchase
Payment performance
Performing	$	43,613	$	95,082	$	48,847	$	30,471	$	7,405	$	28,994	$	254,412
Nonperforming		2,314		7,177		7,340		4,563		1,348		5,059		27,801
Total Residential 1-4<br><br><br>Unit - Purchase	$	45,927	$	102,259	$	56,187	$	35,034	$	8,753	$	34,053	$	282,213
Residential 1-4 Unit - Refinance
Payment performance
Performing	$	93,414	$	232,548	$	107,433	$	69,918	$	25,157	$	41,168	$	569,638
Nonperforming		18,810		67,792		40,706		16,836		7,350		13,939		165,433
Total Residential 1-4<br><br><br>Unit - Purchase	$	112,224	$	300,340	$	148,139	$	86,754	$	32,507	$	55,107	$	735,071
Total Portfolio	$	246,898	$	723,302	$	475,381	$	285,415	$	102,543	$	173,295	$	2,006,834

Note 7 — Securitizations, Net

From May 2011 through September 2020, the Company completed fifteen securitizations of $3.4 billion of loans, issuing $3.1 billion of securities to third parties through fifteen respective Trusts. The Company is the sole beneficial interest holder of the Trusts, which are variable interest entities included in the consolidated financial statements. The transactions are accounted for as secured borrowings under U.S. GAAP. The securities are subject to redemption by the Company when the stated principal balance is less than a certain percentage, ranging from 5%–30% of the original stated principal balance of loans at issuance. As a result, the actual maturity dates of the securities issued could be earlier than their respective stated maturity dates, ranging from September 2044 through July 2050.

The following table summarizes the outstanding balance, net of discounts and deals costs, of the securities and the effective interest rate for the nine months ended September 30, 2020 and 2019 (dollars in thousands):

	Nine Months Ended September 30,
	2020			2019
Securitizations:
Securitizations, net	$	1,670,930		$	1,377,733
Interest expense		58,749			51,852
Average outstanding balance		1,728,131			1,318,649
Effective interest rate (1)		4.53	%		5.24	%
(1)	Represents annualized interest expense divided by average gross outstanding balance and includes average rate (3.94%) and debt issue cost amortization (0.59%) and average rate (4.60%) and debt issue cost amortization (0.64%) for the nine months ended September 30, 2020 and 2019, respectively.
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Note 8 — Other Debt

The secured financing and warehouse facilities were utilized to finance the origination and purchase of commercial real estate mortgage loans. Warehouse facilities are designated to fund mortgage loans that are purchased and originated within specified underwriting guidelines. These lines of credit fund less than 100% of the principal balance of the mortgage loans originated and purchased, requiring the use of working capital to fund the remaining portion.

(a)	Secured Financing, Net (Corporate Debt)

On August 29, 2019, the Company entered into a five-year $153.0 million corporate debt agreement with Owl Rock Capital Corporation, the “2019 Term Loan”. The 2019 Term Loan under this agreement bears interest at a rate equal to one-month LIBOR (with a LIBOR floor that is generally 1.0%) plus 7.50% and matures in August 2024.

As of September 30, 2020 and December 31, 2019, the balance of the 2019 Term Loan was $78.0 million and $153.0 million, respectively. In January 2020, the Company used a portion of its IPO proceeds to pay down $75.0 million in principal amount of the 2019 Term Loan.  The balance in the consolidated Statements of Financial Condition is net of debt issuance costs of $3.2 million and $7.4 million, respectively. The 2019 Term Loan is secured by substantially all assets of the Company not otherwise pledged under a securitization or warehouse facility and contains certain reporting and financial covenants. Should the Company fail to adhere to those covenants or otherwise default under the notes, the lenders have the right to demand immediate repayment that may require the Company to sell the collateral at less than the carrying amounts. As of September 30, 2020 and December 31, 2019, the Company was in compliance with these covenants.

(b)	Warehouse Repurchase and Revolving Loan Facilities, Net

On May 29, 2015, the Company entered into a Repurchase Agreement (“the 2015 Repurchase Agreement”) with a warehouse lender. The 2015 Repurchase Agreement matured on August 3, 2020, and was a short-term borrowing facility, collateralized by a pool of loans, with an initial maximum capacity of $300.0 million, and bore interest at one-month LIBOR plus a margin that ranged from 3.000% to 3.125%. All borrower payments on loans financed under the warehouse repurchase facility were first used to pay interest on the facility. For the nine months ended September 30, 2020 and 2019, the effective interest rates were 5.17% and 5.83%, respectively.

On May 17, 2013, the Company entered into a Repurchase Agreement (“the 2013 Repurchase Agreement”) with another warehouse lender. The 2013 Repurchase Agreement has a current maturity date of September 29, 2021, and is a short-term borrowing facility, collateralized by a pool of performing loans, with a maximum capacity of $100.0 million, and bears interest at one-month LIBOR plus 3.25%. All borrower payments on loans financed under the warehouse repurchase facility are first used to pay interest on the facility. For the nine months ended September 30, 2020 and 2019, the effective interest rates were 4.39% and 5.68%, respectively.

On September 12, 2018, the Company entered into a three-year secured revolving loan facility agreement (“the Bank Credit Agreement) with a bank. The Bank Credit Agreement matures September 12, 2021. During the borrowing period, the Company can take loan advances from time to time subject to availability. Each loan advance bears interest at the lesser of the one-month LIBOR Rate plus 3.5% per annum and the maximum rate, which is the highest lawful and non-usurious rate of interest applicable to the loan. The maximum loan amount under this facility is $50 million. This facility was paid down to zero as of September 30, 2020.

On December 26, 2019, the Company entered into a $3.0 million loan agreement (“the 2019 Loan”) with a lender. The 2019 Loan is secured by five real properties acquired by the Company through foreclosure or by deed-in lieu of foreclosure.  The 2019 Loan bears a fixed interest rate of 9.5%, and matures the earlier of (i) January 1, 2021, and (ii) the date on which the unpaid principal balance of this loan becomes due and payable by acceleration or otherwise pursuant to the loan documents or the exercise by the lender of any right or remedy under any loan document. The maturity date of the 2019 Loan is subject to extension up to July 1, 2021.

On August 4, 2020, the Company entered into a $10.6 million repurchase agreement (“the 2020 Repurchase Agreement) with a large investment bank. The 2020 Repurchase Agreement is secured by $19.7 million of securities issued and retained by the Company through a securitization, and bears interest at three-month LIBOR plus 4.00%. The interest rate was 4.23% as of September 30, 2020. The repurchase date under this agreement is November 24, 2020.

Certain of the Company’s loans are pledged as security under the warehouse repurchase facilities and the revolving loan facility, which contain covenants. Should the Company fail to adhere to those covenants or otherwise default under the facilities, the lenders have the right to terminate the facilities and demand immediate repayment that may require the Company to sell the collateral at less than the carrying amounts. As of September 30, 2020 and December 31, 2019, the Company was in compliance with these covenants.

The following table summarizes the maximum borrowing capacity and current gross balances outstanding for the Company’s warehouse facilities and loan agreements as of September 30, 2020 and December 31, 2019 (in thousands):

	September 30, 2020				December 31, 2019
	Period end<br><br><br>balance^(1)^		Maximum<br><br><br>borrowing<br><br><br>capacity		Period end<br><br><br>balance^(1)^		Maximum<br><br><br>borrowing<br><br><br>capacity
The 2015 repurchase agreement	$	—	$	—	$	226,212	$	250,000
The 2013 repurchase agreement		6,476		100,000		190,977		200,000
The Bank credit agreement		—		—		2,499		50,000
The 2019 loan agreement		2,700		3,000		3,000		3,000
The 2020 repurchase agreement		10,647		10,647		—		—
(1)	Warehouse repurchase facilities amounts in the consolidated balance sheets are net of debt issuance costs amounting to $0.3 million and $1.1 million as of September 30, 2020 and December 31, 2019, respectively.
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The following table provides an overview of the activity and effective interest rate for the nine months ended September 30, 2020 and 2019 (dollars in thousands):

	Nine Months Ended September 30,
	2020			2019
Warehouse and repurchase facilities:
Average outstanding balance	$	204,110		$	216,613
Highest outstanding balance at any month-end		450,194			349,859
Effective interest rate (1)		4.99	%		5.76	%
(1)	Represents annualized interest expense divided by average gross outstanding balance and includes average rate (4.34%) and debt issue cost amortization (0.65%) and average rate (5.35%) and debt issue cost amortization (0.41%) for the nine months ended September 30, 2020 and 2019, respectively.
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The following table provides a summary of interest expense that includes debt issuance cost amortization, interest, amortization of discount, and deal cost amortization for the nine months ended September 30, 2020 and 2019 (in thousands):

	Nine Months Ended September 30,
Warehouse and repurchase facilities	$	7,635		$	9,362
Securitizations		58,749			51,852
Interest expense — portfolio related		66,384			61,214
Interest expense — corporate debt		10,149	(1)		10,548
Total interest expense	$	76,533		$	71,762
(1)	Included in the $10.1 million of interest expense – corporate debt for the nine months ended September 30, 2020 was the one-time debt issuance costs write-off of $3.5 million and prepayment penalties of $0.3 million associated with the repayment of $75.0 million in outstanding principal amount in January 2020.
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Note 9 — Commitments and Contingencies

(a)	Repurchase Liability

When the Company sells loans, it is required to make normal and customary representations and warranties about the loans to the purchaser. The loan sale agreements generally require the Company to repurchase loans if the Company breaches a representation or warranty given to the loan purchaser. In addition, the Company may be required to repurchase loans as a result of borrower fraud or if a payment default occurs on a loan shortly after its sale.

The Company records a repurchase liability relating to representations and warranties and early payment defaults. The method used to estimate the liability for repurchase is a function of the representations and warranties given and considers a combination of factors, including, but not limited to, estimated future defaults and loan repurchase rates and the potential severity of loss in the event of defaults. The Company establishes a liability at the time loans are sold and continually updates the estimated repurchase liability. The level of the repurchase liability for representations and warranties and early payment default requires considerable management judgment. As of September 30, 2020 and December 31, 2019, the balance of repurchase liability was $76 thousand, and it is included in accounts payable and accrued expenses in the consolidated balance sheets.

(b)	Legal Proceedings

The Company is a party to various legal proceedings in the normal course of business. The Company, after consultation with legal counsel, believes the disposition of all pending litigation will not have a material effect on the Company’s consolidated financial condition or results of operations.

Note 10 — Members’ Equity

Prior to the conversion of Velocity Financial, LLC into a corporation, the Company had the authority to issue four types of membership units, Class A, Class B, Class C, and Class D units. The Class A units represented ownership interests in VF. Class B units were profit interest units, which represented a right to share, with the Class A units, in the distribution of profits earned by the Company. The Class C and Class D units were preferred units, which had the right to convert to Class A units.

The Company repurchased all outstanding Class C preferred units for an aggregate purchase price equal to the Class C liquidation preference of approximately $27.7 million on August 29, 2019. All Class A and Class D units were converted to common stock upon the conversion of the Company into a corporation on January 16, 2020. All Class B units were converted at zero value upon the conversion of the Company into a corporation on January 16, 2020. Prior to the Company’s IPO, the outstanding Class A, Class B and Class D units and equity balance were as follows as of December 31, 2019 ($ in thousands):

	December 31, 2019
Class A units issued and outstanding		97,514
Class A equity balance	$	92,650
Class B units issued and outstanding		16,072
Class B equity balance	$	—
Class D units issued and outstanding		60,194
Class D equity balance	$	60,194

Note 11 — Stock-Based Compensation

The Company’s 2020 Omnibus Incentive Plan, or the 2020 Plan, authorized grants of stock‑based compensation instruments to purchase or issue up to 1,520,000 shares of Company common stock. In connection with its IPO in January 2020, the Company granted stock options to non-employee directors and certain employees, including named executive officers to purchase approximately 782,500 shares of common stock with an exercise price per share equal to the initial public offering price of $13.00.

Stock options vest ratably over a service period of three years from the date of the grant. Compensation expense related to stock options is based on the fair value of the underlying stock on the award date and is recognized over the vesting period using the straight‑line method. For the nine months ended September 30, 2020, 10,000 shares of stock options were forfeited, and the Company recognized $0.5 million compensation expense related to the outstanding stock options granted to employees. Such amount is included in “Compensation and employee benefits” on the Consolidated Statement of Income. The amount of unrecognized compensation expense related to unvested stock options totaled $2.3 million as of September 30, 2020. As of September 30, 2020, unvested stock options outstanding were 772,500 shares at an exercise price per share of $13.00.

Note 12 — Earnings (Loss) Per Share

The two-class method is used in the calculation of basic and diluted earnings per share. Under the two-class method, earnings available to common shareholders for the period are allocated between common shareholders and participating securities according to dividends declared (or accumulated) and participation rights in undistributed earnings. Basic earnings per share is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if stock options or other contracts to issue common stock were exercised or converted into common stock and resulted in the issuance of common stock that shared in earnings.

The following table presents the basic and diluted earnings (loss) per share calculations for the three and nine months ended September 30, 2020:

	Three Months Ended		Nine Months Ended
	September 30, 2020		September 30, 2020
	(In thousands, except per share data)
Basic EPS:
Net income	$	3,481	$	8,201
Less deemed dividends on preferred stock		—		48,955
Net income (loss) allocated to common stock	$	3,481	$	(40,754	)
Less earnings allocated to participating securities		—		—
Net earnings (loss) allocated to common stock	$	3,481	$	(40,754	)
Weighted average common shares outstanding		20,087		20,087
Basic earnings (loss) per common share	$	0.17	$	(2.03	)
Diluted EPS:
Net income (loss) allocated to common shareholders	$	3,481	$	(40,754	)
Weighted average common shares outstanding		20,087		20,087
Add dilutive effects for assumed conversion of Series A preferred stock		11,688		—
Add dilutive effects for warrants		659		—
Add dilutive effects for stock options		—		—
Weighted average diluted common shares outstanding		32,435		20,087
Diluted income (loss) per common share	$	0.11	$	(2.03	)

Earnings per common share is not applicable to periods prior to the Company's IPO on January 17, 2020.

The following table sets forth the number of shares excluded from the computation of diluted loss per share, as their inclusion would have been anti-dilutive:

	Three Months Ended		Nine Months Ended
	September 30, 2020		September 30, 2020
Shares underlying Series A Convertible Preferred Stock		—		11,688,312
Shares underlying warrants		1,004,375		3,013,125
Stock options		772,500		772,500
Share equivalents excluded from EPS		1,776,875		15,473,937

Note 13 — Convertible Preferred Stock

On April 7, 2020, the Company issued and sold in a private placement 45,000 newly issued shares of Series A Convertible Preferred Stock, par value $0.01 per share (the “Preferred”), at a price per share of $1,000, plus warrants (the “Warrants”) to purchase an aggregate of 3,013,125 shares of the Company’s common stock to funds affiliated with Snow Phipps and a fund affiliated with Pacific Investment Management Company LLC (TOBI). Snow Phipps and TOBI are considered affiliates and, therefore, are related parties to the Company. This offering resulted in net proceeds to the Company of $43.2 million. In connection with these transactions, the Company entered into a securities purchase agreement with Snow Phipps and TOBI granting TOBI the right to nominate an additional director to the Company’s board of directors for so long as TOBI and its permitted transferees meet certain ownership thresholds.

The Preferred ranks senior to the Company’s common stock with respect to the payment of dividends and distribution of assets upon liquidation, dissolution and winding up. It is entitled to receive any dividends or distributions paid in respect of the common stock on an as-converted basis and has no stated maturity and will remain outstanding indefinitely unless converted into common stock or repurchased by the Company. Holders of the Preferred will be entitled to vote, together with the holders of common stock, on an as-converted basis, subject to limitations of the rules of the New York Stock Exchange, on all matters submitted to a vote of the holders of common stock, and as a separate class as required by law. The holders of the Preferred will also have the right to elect two directors to the board of directors of the Company if the Company defaults under its obligation to repurchase the Preferred.

The Preferred has a liquidation preference equal to the greater of (i) $2,000 per share from April 7, 2020 through October 7, 2022, which amount increases ratably to $3,000 per share from October 8, 2022 through November 28, 2024 and to $3,000 per share from and after November 28, 2024 and (ii) the amount such holder would have received if the Preferred had converted into common stock immediately prior to such liquidation.

Following shareholder approval at the Special Meeting of Shareholders held on August 13, 2020, each share of the Preferred is convertible at the option of the holder into the number of shares of common stock equal to then applicable conversion rate of $1,000 divided by the applicable conversion price plus cash in lieu of fractional shares, if any. The initial conversion price is $3.85 and is subject to customary antidilution adjustments. In addition, the Company has the right to cause the Preferred to convert beginning October 7, 2021 if the Company’s common stock meets certain weighted average price targets.

Beginning on October 7, 2022, if permitted by the terms of the Company’s material indebtedness, and in no event later than November 28, 2024, holders of the Preferred have the option to cause the Company to repurchase all or a portion of such holder’s shares of Preferred, for an amount in cash equal to such share’s liquidation preference. If the Company defaults on its repurchase obligation, the holders of the Preferred have the right (until the repurchase price has been paid in full, in cash, or such the Preferred has been converted) to force a sale of the Company and the holders of the Preferred will have the right to elect two directors of the Company’s Board until such default is cured. The Company is also required to redeem the Preferred upon a change of control (as defined in the certificate of designation governing the Preferred).

The Warrants are exercisable at the warrantholder’s option at any time and from time to time, in whole or in part, until April 7, 2025 at an exercise price of $2.96 per share of common stock, with respect to 2,008,750 of the Warrants, and at an exercise price of $4.94 per share of common stock, with respect to 1,004,375 of the Warrants. The exercise price and the number of shares of common stock issuable upon exercise of the Warrants are subject to customary antidilution adjustments and certain issuances of common stock (or securities convertible into or exercisable for common stock) at a price (or having a conversion or exercise price) that is less than the then current exercise price. The Company is not required to affect an exercise of Warrants, if after giving effect to the issuance of common stock upon exercise of such Warrants such warrantholder together with its affiliates would beneficially own 49% or more of the Company’s outstanding common stock.

The Company determined that none of the features embedded in the Preferred were required to be accounted for separately as a derivative.

The Preferred is recorded as mezzanine equity (temporary equity) on the consolidated balance sheets because it is not mandatorily redeemable, but does contain a redemption feature at the option of the preferred stock holders that is considered not solely within the Company’s control. Because the Preferred becomes redeemable at any time after 2.5 years from the Closing Date of April 7, 2020, the Company has elected to recognize the changes in the maximum redemption value immediately as they occur and adjust the carrying value of the Preferred to equal the maximum redemption value at the end of each reporting period which is viewed as the redemption date for the Preferred. At June 30, 2020, the Company recognized the Preferred maximum redemption value of $90 million, which is the maximum redemption value on the earliest redemption date based on a redemption value of $2,000 per share and 45,000 shares of Preferred. The recording of the Preferred maximum redemption value was treated as a deemed dividend and resulted in a $49 million charge to Shareholders’ Equity.

Note 14 — Fair Value Measurements

(a)	Fair Value Determination

ASC Topic 820, “Fair Value Measurement,” defines fair value, establishes a framework for measuring fair value including a three-level valuation hierarchy, and requires disclosures about fair value measurements. Fair value is defined as the exchange price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date reflecting assumptions that a market participant would use when pricing an asset or liability. The hierarchy uses three levels of inputs to measure the fair value of assets and liabilities as follows:

•	Level 1 - Valuation is based on quoted prices for identical instruments traded in active markets.
•	Level 2 - Valuation is based on quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable and can be corroborated by market data.
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•	Level 3 - Valuation is based on significant unobservable inputs for determining the fair value of assets or liabilities. These significant unobservable inputs reflect assumptions that market participants may use in pricing the assets or liabilities.
---	---

Given the nature of some of the Company’s assets and liabilities, clearly determinable market-based valuation inputs are often not available; therefore, these assets and liabilities are valued using internal estimates. As subjectivity exists with respect to the valuation estimates used, the fair values disclosed may not equal prices that can ultimately be realized if the assets are sold or the liabilities are settled with third parties.

Below is a description of the valuation methods for the assets and liabilities recorded at fair value on either a recurring or nonrecurring basis and for estimating fair value of financial instruments not recorded at fair value for disclosure purposes. While management believes the valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the measurement date.

(b)	Cash and Cash Equivalents and Restricted Cash

Cash and restricted cash are recorded at historical cost. The carrying amount is a reasonable estimate of fair value as these instruments have short-term maturities and interest rates that approximate market, a Level 1 measurement.

(c)	Loans Held for Investment

Loans held for investment are recorded at their outstanding principal balance, net of purchase discounts, deferred loan origination fees/costs, and allowance for credit losses.

The Company determined the fair value estimate of loans held for investment using a third-party loan valuation model, a Level 3 measurement. The significant unobservable inputs used in the fair value measurement of the Company’s mortgage loans held for investment are discount rates, prepayment speeds, loss severity, and default rates. Significant changes in any of those inputs could result in a significant change to the loans’ fair value measurement.

(d)	Collateral Dependent or Loans Individually Evaluated

Nonaccrual loans held for investment are evaluated individually and are recorded at fair value on a nonrecurring basis. To the extent a loan is collateral dependent, the Company determines the allowance for credit losses based on the estimated fair value of the underlying collateral. The fair value of each loan’s collateral is generally based on appraisals or broker price opinions obtained, less estimated costs to sell, a Level 3 measurement.

(e)	Loans Held for Sale

Loans held for sale are carried at the lower of cost or fair value, with fair value adjustments recorded on a nonrecurring basis. The Company uses a discounted cash flow model to estimate the fair value of loans held for sale, a Level 3 measurement.

(f)	Interest-Only Strips

The Company retains an interest-only strip on certain sales of held for sale loans. The interest-only strips are classified as trading securities under FASB ASC Topic 320, Investments-Debt Securities. The interest-only strips are measured based on their estimated fair values using a discounted cash flow model, a Level 3 measurement. Changes in fair value are reflected in income as they occur.

(g)	Loans Held for Investment, at Fair Value

The Company has elected to account for certain purchased distressed loans held for investment, at fair value (the FVO Loans) using FASB ASC Topic 825, Financial Instruments (ASC 825). The FVO loans are measured based on their estimated fair values. Management identified all of these loans to be accounted for at estimated fair value at the instrument level. Changes in fair value are reflected in income as they occur.

The Company uses a third-party loan valuation model to estimate the fair value at instrument level, a Level 3 measurement. The significant unobservable inputs used in the fair value measurement of the Company’s mortgage loans held for investment, at fair value are discount rate, property values, prepayment speeds, loss severity, and default rates. Significant changes in any of those inputs in isolation could result in a significant change to the loans’ fair value measurement.

(h)	Real Estate Owned, Net (REO)

Real estate owned, net is initially recorded at the property’s estimated fair value, based on appraisals or broker price opinions obtained, less estimated costs to sell, at the acquisition date, a Level 3 measurement. From time to time, nonrecurring fair value adjustments are made to real estate owned, net based on the current updated appraised value of the property, or management’s judgment and estimation of value based on recent market trends or negotiated sales prices with potential buyers.

(i)	Secured Financing, Net (Corporate Debt)

The Company determined the fair values estimate of the secured financing using the estimated cash flows discounted at an appropriate market rate, a Level 3 measurement.

(j)	Warehouse Repurchase Facilities, Net

Warehouse repurchase facilities are recorded at historical cost. The carrying amount is a reasonable estimate of fair value as these instruments have short-term maturities of one-year or less and interest rates that approximate market plus a spread, a Level 2 measurement.

(k)	Securitizations, Net

The fair value estimate of securities issued is determined by using estimated cash flows discounted at an appropriate market rate, a Level 3 measurement.

(l)	Accrued Interest Receivable and Accrued Interest Payable

The carrying amounts of accrued interest receivable and accrued interest payable approximate fair value due to the short-term nature of these instruments, a Level 1 measurement.

The Company does not have any off-balance sheet financial instruments.

(m)	Fair Value Disclosures

The following tables present information on assets measured and recorded at fair value as of September 30, 2020 and December 31, 2019, by level, in the fair value hierarchy (in thousands):

	Fair value measurements using						Total at
September 30, 2020	Level 1		Level 2		Level 3		fair value
Recurring fair value measurements:
Loans held for investment, at fair value	$	—	$	—	$	3,327	$	3,327
Interest-only strips		—		—		473		473
Total recurring fair value measurements		—		—		3,800		3,800
Nonrecurring fair value measurements:
Real estate owned, net		—		—		14,653		14,653
Individually evaluated loans requiring specific allowance, net		—		—		20,202		20,202
Total nonrecurring fair value measurements		—		—		34,855		34,855
Total assets	$	—	$	—	$	38,655	$	38,655
	Fair value measurements using						Total at
---	---	---	---	---	---	---	---	---
December 31, 2019	Level 1		Level 2		Level 3		fair value
Recurring fair value measurements:
Loans held for investment, at fair value	$	—	$	—	$	2,960	$	2,960
Interest-only strips		—		—		894		894
Total recurring fair value measurements		—		—		3,854		3,854
Nonrecurring fair value measurements:
Loans held for sale, net		—		—		214,467		214,467
Real estate owned, net		—		—		13,068		13,068
Impaired loans requiring specific allowance, net		—		—		11,373		11,373
Total nonrecurring fair value measurements		—		—		238,908		238,908
Total assets	$	—	$	—	$	242,762	$	242,762

The following table presents gains and losses recognized on assets measured on a nonrecurring basis for the three and nine months ended September 30, 2020 and 2019 (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
Gain (loss) on assets measured on a nonrecurring basis	2020			2019			2020			2019
Loans held for sale, net	$	1,307		$	15		$	345		$	84
Real estate held for sale, net		(528	)		(195	)		(1,744	)		(572	)
Individually evaluated loans requiring specific allowance, net		(1,109	)		65			(1,469	)		(103	)
Total net loss	$	(330	)	$	(115	)	$	(2,868	)	$	(591	)

The following tables present the primary valuation techniques and unobservable inputs related to Level 3 assets as of September 30, 2020 and December 31, 2019 (dollars in thousands):

	September 30, 2020
Asset category	Fair value		Primary<br><br><br>valuation<br><br><br>technique	Unobservable<br><br><br>input	Range	Weighted<br><br><br>average
Individually evaluated<br><br><br>loans requiring allowance, net	$	20,202	Market comparables	Selling costs	8.0%	8.0%
Real estate owned, net		14,653	Market comparables	Selling costs	8.0%	8.0%
Loans held for investment,<br><br><br>at fair value		3,327	Discounted cash flow	Discount rate	7.11%	7.11%
				Collateral value (% of UPB)	92% to 102%	99%
				Timing of resolution/payoff (months)	1 to 32		12
				Prepayment rate	13.83%	13.83%
				Default rate	4.75% to 15.44%	11.0%
				Loss severity rate	0.60%	0.60%
Interest-only strips	473		Discounted cash flow	Discount rate	15.0%	15.0%
				Timing of resolution/payoff (months)	0 to 12		2.0
	December 31, 2019
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Asset category	Fair value		Primary<br><br><br>valuation<br><br><br>technique	Unobservable<br><br><br>input	Range	Weighted<br><br><br>average
Collateral dependent<br><br><br>impaired loans requiring<br><br><br>specific allowance, net	$	11,373	Market comparables	Selling costs	8.0%	8.0%
Real estate owned, net		13,068	Market comparables	Selling costs	8.0%	8.0%
Loans held for investment,<br><br><br>at fair value		2,960	Discounted cash flow	Discount rate	10.5%	10.5%
				Collateral value (% of UPB)	18.0% to 94.0%	87.0%
				Timing of resolution/payoff (months)	5 to 218		65.0
				Prepayment rate	15.0%	15.0%
				Default rate	1.0%	1.0%
				Loss severity rate	10.0%	10.0%
Loans held for sale		214,467	Discounted cash flow	Discount rate	12.0% to 15.0%	14.7%
				Timing of resolution/payoff (months)	0 to 12		7.0
Interest-only strips	894		Discounted cash flow	Discount rate	15%	15%
				Timing of resolution/payoff (months)	0 to 7.0	210.0%

The following is a rollforward of loans that are measured at estimated fair value on a recurring basis for the periods indicated (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2020			2019			2020			2019
Beginning balance	$	2,956		$	2,974		$	2,960		$	3,463
Loans liquidated		—			—			—			(421	)
Principal paydowns		(9	)		(21	)		(44	)		(55	)
Total unrealized gain (loss) included in net income		380			(17	)		411			(51	)
Ending balance	$	3,327		$	2,936		$	3,327		$	2,936

The following is a rollforward of interest-only strips that are measured at estimated fair value on a recurring basis for the periods indicated (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2020			2019			2020			2019
Beginning balance	$	845		$	1,193		$	894		$	812
Interest-only strip additions		—			—			1,820			1,634
Interest-only strip write-offs		(365	)		(499	)		(2,234	)		(1,630	)
Total unrealized loss included in net income		(7	)		—			(7	)		(122	)
Ending balance	$	473		$	694		$	473		$	694

The Company estimates the fair value of certain financial instruments on a quarterly basis. These instruments are recorded at fair value through the use of a valuation allowance only if they are individually evaluated. As described above, these adjustments to fair value usually result from the application of lower of cost or fair value accounting or write-downs of individual assets. As of September 30, 2020 and December 31, 2019, the only financial assets measured at fair value were certain individually evaluated loans held for investment, loans held for sale, interest-only strips, REO and FVO loans, which were measured using unobservable inputs, including appraisals and broker price opinions on the values of the underlying collateral. Individually evaluated loans requiring an allowance were carried at approximately $20.2 million and $11.4 million as of September 30, 2020 and December 31, 2019, net of specific allowance for credit losses of approximately $2.4 million and $0.9 million, respectively.

A financial instrument is cash, evidence of an ownership interest in an entity, or a contract that creates a contractual obligation or right to deliver or receive cash or another financial instrument from a second entity on potentially favorable terms. The methods and assumptions used in estimating the fair values of the Company’s financial instruments are described above.

The following tables present carrying amounts and estimated fair values of certain financial instruments as of the dates indicated (in thousands):

	September 30, 2020
	Carrying								Estimated
Asset category	Value		Level 1		Level 2		Level 3		Fair Value
Assets:
Cash	$	19,210	$	19,210	$	—	$	—	$	19,210
Restricted cash		7,821		7,821		—		—		7,821
Loans held for investment, net		2,001,086		—		—		2,019,669		2,019,669
Loans held for investment, at fair value		3,327		—		—		3,327		3,327
Accrued interest receivables		13,134		13,134		—		—		13,134
Interest-only strips		473		—		—		473		473
Liabilities:
Secured financing, net	$	74,776	$	—	$	—	$	77,900	$	77,900
Warehouse repurchase facilities, net		19,541		—		19,541		—		19,541
Securitizations, net		1,670,930		—		—		1,714,210		1,714,210
Accrued interest payable		7,399		7,399		—		—		7,399
	December 31, 2019
---	---	---	---	---	---	---	---	---	---	---
	Carrying								Estimated
Asset category	Value		Level 1		Level 2		Level 3		Fair Value
Assets:
Cash	$	21,465	$	21,465	$	—	$	—	$	21,465
Restricted cash		6,087		6,087		—		—		6,087
Loans held for sale, net		214,467		—		—		222,260		222,260
Loans held for investment, net		1,863,360		—		—		1,913,481		1,913,481
Loans held for investment, at fair value		2,960		—		—		2,960		2,960
Accrued interest receivable		13,295		13,295		—		—		13,295
Real estate owned, net		13,068		—		—		13,068		13,068
Interest-only strips	894			—		—	894		894
Liabilities:
Secured financing, net	$	145,599	$	—	$	—	$	153,000	$	153,000
Warehouse repurchase facilities, net		421,548		—		421,548		—		421,548
Securitizations, net		1,438,629		—		—		1,486,990		1,486,990
Accrued interest payable		7,190		7,190		—		—		7,190

Note 15 — Subsequent Events

The Company has evaluated events that have occurred subsequent to September 30, 2020 through the issuance of the accompanying consolidated financial statements and has concluded there are no other subsequent events that would require recognition or disclosure in the accompanying consolidated financial statements.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion should be read in conjunction with the information included in our Annual Report on Form 10-K for the year ended December 31, 2019, the risk factors contained in our Form 10-Q for the quarter ended March 31, 2020 as well as the unaudited financial statements included elsewhere in this Quarterly Report on Form 10-Q (the “Quarterly Report”).

In addition, the statements and assumptions in this Quarterly Report that are not statements of historical fact are forward-looking statements within the meaning of federal securities laws. In particular, statements about our plans, strategies and prospects as well as estimates of industry growth for the next quarter and beyond are forward-looking statements. For important information regarding these forward-looking statements, please see the discussion below under the caption “Cautionary Note on Forward-Looking Statements.”

References to “the Company,” “Velocity,” “we,” “us” and “our” refer to Velocity Financial, Inc. and include all of its consolidated subsidiaries, unless otherwise indicated or the context requires otherwise.

Business

We are a vertically integrated real estate finance company founded in 2004. We primarily originate and manage investor loans secured by 1-4 unit residential rental and small commercial properties, which we refer to collectively as investor real estate loans. We originate loans nationwide across our extensive network of independent mortgage brokers which we have built and refined over the 15 years since our inception. Our objective is to be the preferred and one of the most recognized brands in our core market, particularly within our network of mortgage brokers.

We operate in a large and highly fragmented market with substantial demand for financing and limited supply of institutional financing alternatives. We have developed the highly-specialized skill set required to effectively compete in this market, which we believe has afforded us a durable business model. We offer competitive pricing to our borrowers by pursuing low-cost financing strategies and by driving front- end process efficiencies through customized technology designed to control the cost of originating a loan. Furthermore, by originating loans through our efficient and scalable network of approved mortgage brokers, we are able to maintain a wide geographical presence and nimble operating infrastructure capable of reacting quickly to changing market environments.

Our primary source of revenue is interest income earned on our loan portfolio. Our typical loan is secured by a first lien on the underlying property with a personal guarantee and, based on all loans in our portfolio as of September 30, 2020, has an average balance of approximately $329,000. As of September 30, 2020, our loan portfolio totaled $2.0 billion of UPB on properties in 45 states and the District of Columbia. The total portfolio had a weighted average loan-to-value ratio, or LTV at origination, of 66.2%, and was concentrated in 1-4 unit residential rental loans, which we refer to as investor 1-4 loans, representing 50.7% of the UPB. For the three months ended September 30, 2020, the annualized yield on our total portfolio was 8.21%.

We fund our portfolio primarily through a combination of committed and uncommitted secured warehouse repurchase facilities, securitizations, corporate debt and equity. The securitization market is our primary source of long-term financing. We have successfully executed fifteen securitizations, resulting in a total of over $3.1 billion in gross debt proceeds from May 2011 through September 2020.

One of our core profitably measurements is our portfolio related net interest margin, which measures the difference between interest income earned on our loan portfolio and interest expense paid on our portfolio-related debt, relative to the amount of loans outstanding over the period. Our portfolio-related debt consists of our warehouse repurchase facilities and securitizations and excludes our corporate debt. For the three months ended September 30, 2020, our annualized portfolio related net interest margin was 3.77%, an improvement of 23 basis points over the previous quarter. We generate profits to the extent that our portfolio related net interest income exceeds our interest expense on corporate debt, provision for loan losses and operating expenses. For the three months ended September 30, 2020, we generated pre-tax income and net income of $5.0 million and $3.5 million, respectively.

In January 2020, we completed the initial public offering of our common stock, par value $0.01 per share (our “common stock”). We received net proceeds received from the sale of our common stock in the IPO of $100.7 million, a portion of which we used to repay $75.0 million of principal on our existing corporate debt.

On April 7, 2020, we issued and sold 45,000 shares of our newly designated Series A Convertible Preferred Stock, par value $0.01 per share (the “Preferred Stock”), in a private placement to affiliates of Snow Phipps and TOBI (the “Purchasers”), our two largest common stockholders, at a price per share of  Preferred Stock of $1,000. In addition, as part of that private placement, we issued and sold to the Purchasers warrants (the “Warrants”) to purchase an aggregate of 3,013,125 shares of our common stock. This private placement offering resulted in gross proceeds to us of $45.0 million. We used the proceeds from this private placement to pay down our existing warehouse repurchase facilities and for general corporate purposes

Items Affecting Comparability of Results

Due to a number of factors, our historical financial results may not be comparable, either from period to period, or to our financial results in future periods. We have summarized the key factors affecting the comparability of our financial results below.

In 2014, we entered into a five-year, $100.0 million corporate debt agreement with the owners of our Class C preferred units, pursuant to which we issued at par senior secured notes, the 2014 Senior Secured Notes, that was due on December 16, 2019. The 2014 Senior Secured Notes bore interest, at our election, at either 10% annually paid in cash or 11% annually paid in kind.

In August 2019, we entered into a five-year $153.0 million corporate debt agreement with Owl Rock Capital Corporation (“2019 Term Loan”). The 2019 Term Loan under this agreement bears interest at a rate equal to one-month LIBOR plus 7.50% and mature in August 2024. A portion of the net proceeds from the 2019 Term Loan was used to redeem all of the outstanding 2014 Senior Secured Notes in August 2019. Another portion of the net proceeds from the 2019 Term Loan, together with cash on hand, was used to repurchase our outstanding Class C preferred units.

In January 2020, we used $75.7 million of the net proceeds from our IPO to lower our interest expense through the repayment of $75.0 million outstanding principal amount on the 2019 Term Loan.

In late March 2020, we temporarily suspended our loan originations and purchases due to the business and economic uncertainties caused by the COVID-19 outbreak. In addition, effective May 1, 2020, we furloughed a significant number of our employees, mostly within our loan origination function.

On April 7, 2020, we issued and sold Preferred Stock and Warrants resulting in gross proceeds to us of $45.0 million.

In September 2020, we resumed loan originations and took in over $220 million of loan applications during the month.  We also enhanced our loan operations processes during the temporary suspension, enabling us to streamline our operations by approximately 60 employees to be more cost effective going forward.

Recent Developments

Strategies to Address Uncertainties Caused by COVID-19

The COVID-19 outbreak has caused significant disruption in business activity and the financial markets both globally and in the United States. As a result of the spread of COVID-19, economic uncertainties have arisen which have negatively impacted our financial condition, results of operations and cash flows. The further extent of the impact of COVID-19 on our operational and financial performance will depend on certain developments, including the duration and spread of the outbreak and impact on our customers, employees and vendors, all of which remain uncertain at this time and cannot be predicted.

We have executed a number of business initiatives as a result of the effects of the COVID-19 pandemic, including the following:

•	As mentioned, we temporarily suspended our loan originations and loan purchases and furloughed a significant number of our employees, mostly within our loan origination function. During the quarter ended June 30, 2020, we did not originate any loans and did not purchase any loans.
•	We issued and sold Preferred Stock and Warrants resulting in gross proceeds to us of $45.0 million. We used the proceeds from this private placement to pay down our existing warehouse repurchase facilities and for general corporate purposes.
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•	On April 6, 2020, we entered into amendments to the master repurchase agreements on both of our warehouse repurchase agreements with the lenders under such agreements. Each of these agreements were completely paid down with the 2020- MC1 securitization that closed in July.
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•	We have implemented a COVID-19 forbearance program designed to help small investors retain their properties and minimize our portfolio losses.
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•	On July 10, 2020, we securitized $276.0 million of short-term and long-term investor real estate loans and issued $179.4 million of notes and certificates. We used the proceeds from this securitization to fully pay off our existing warehouse lines.
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•	We are exploring new non-mark to market financing agreements for originating and purchasing loans.
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•	In September 2020, we resumed our loan origination activities. We reduced our workforce by 60 employees as we streamlined our loan operations processes.
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•	In order to protect our employees, we have been working remotely since late March. In addition, we have implemented COVID-19-related protective measures and protocols to safely allow a limited number of staff to work from our offices located across the country.
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Critical Accounting Policies and Use of Estimates

The preparation of financial statements in accordance with U.S. GAAP requires certain judgments and assumptions, based on information available at the time of preparation of the consolidated financial statements, in determining accounting estimates used in preparation of the consolidated financial statements. The following discussion addresses the accounting policies that we believe apply to us based on the nature of our operations. Our most critical accounting policies involve decisions and assessments that could affect our reported assets and liabilities, as well as our reported revenues and expenses. We believe that all of the decisions and assessments used to prepare our financial statements are based upon reasonable assumptions given the information available at that time. We believe the following are critical accounting policies that require the most significant judgments and estimates used in the preparation of the consolidated financial statements. The summary below should be read in conjunction with the disclosure of our accounting policies and use of estimates in Note 2 to the consolidated financial statements.

Allowance for Credit Losses

Effective January 1, 2020, we adopted ASU 2016-13 Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments using the open pool methodology for all financial assets measured at amortized cost, which as of the adoption date consisted entirely of our held for investment loan portfolio.

ASU 2016-13 replaces the incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (CECL) methodology. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loan receivables held for investment. Under the CECL methodology, the allowance for credit losses is measured on a collective (pool) basis when similar risk characteristics exist. We identified the following portfolio segments based on risk characteristics of the loans in its loan portfolio (pool):

•	Residential 1– 4 Unit – Purchase (loans to purchase 1– 4 unit residential rental properties);
•	Residential 1– 4 Unit – Refinance (refinance loans on 1– 4 unit residential rental properties);
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•	Commercial – Purchase (loans to purchase traditional commercial properties) and
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•	Commercial – Refinance (refinance loans on traditional commercial properties).
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We determined the collectability of our loans by evaluating certain risk characteristics. The segmentation of its loan portfolio was determined based on analyses of our loan portfolio performance over the past seven years. Based on analyses of the loan portfolio’s historical performance, we concluded that loan purpose and product types are the most significant risk factors in determining its expectation of future loan losses. Loan purpose considers whether a borrower is acquiring the property or refinancing an existing property. Our historical experience shows that refinance loans have higher loss rates than acquisitions. Product type includes residential 1-4 unit property and traditional commercial property. Our historical experience shows that traditional commercial property loans have higher loss rates than residential 1-4 unit property.

To determine the loss rates used for the open pool methodology, we start with our historical database of losses, segment the loans by loan purpose and product type, and then adjust the loss rates based upon macroeconomic forecasts over a reasonable and supportable period. The reasonable and supportable period is meant to represent the period in which we believe the forecasted macroeconomic variables can be reasonably estimated.

In determining the January 1, 2020 CECL transition impact, we used a third-party model with a four-quarter reasonable and supportable forecast period followed by a four-quarter straight-line reversion period.  Management determined that a four-quarter forecast period and four-quarter straight-line reversion period were appropriate for the January 1, 2020 initial CECL estimate because, as of the beginning of the year, the economy was strong, unemployment and interest rates were low, and GDP was expected to have a modest increase during 2020.  Management concluded that using a 1-year forecast trending steadily back to our historical loss levels best fit the strong, stable economy at that time.

For the September 30, 2020 CECL estimate, the Company used a COVID-19 stress scenario with a five-quarter reasonable and supportable forecast period followed by a four-quarter straight-line reversion period. Management concluded that using the same forecast and reversion periods as last quarter was still appropriate given the extended COVID-19 pandemic and prolonged shutdowns. This forecast period and reversion to historical loss is subject to change as conditions in the market change and the Company’s ability to forecast economic events evolves.

Loans 90 days or more delinquent and not included in our COVID-19 forbearance program, in bankruptcy, or in foreclosure, are evaluated individually. Loans individually evaluated are excluded from loans evaluated collectively by segment. When loans are individually evaluated, we primarily rely on the value of the underlying real estate, coupled with low loan-to-value ratios, to satisfy the loan obligation, either through successful loss mitigation efforts or foreclosure and sale of the underlying real estate. Expected loan losses are based on the fair value of the collateral underlying the loans at the reporting date, adjusted for estimated selling costs as appropriate.

The allowance for credit losses is a valuation account that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on the loans. Loans are charged off against the allowance when we believe the uncollectibility of a loan balance is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off.

We estimate the allowance using relevant available information, from internal and external sources, relating to historical performance, current conditions, and reasonable and supportable macroeconomic forecasts. Historical credit loss experience provides the basis for the estimation of expected credit losses.  Adjustments to historical loss information are considered for differences in current loan-specific risk characteristics such as differences in underwriting standards, portfolio mix, delinquency levels, or term, as well as for changes in environmental conditions, such as unemployment rates, property values and changes in the competitive or regulatory environment.

The allowance for credit losses is maintained at a level deemed adequate by management to provide for expected losses in the portfolio at the balance sheet date. While management uses available information to estimate its required allowance for credit losses, future additions to the allowance for credit losses may be necessary based on changes in estimates resulting from economic and other conditions.

Interest income on loans held for investment is accrued on the unpaid principal balance (UPB) at their respective stated interest rates. Generally, loans are placed on nonaccrual status when they become 90 days past due. Loans are considered past due when contractually required principal or interest payments have not been made on the due dates. Management has concluded that ASC 310-20-35-18(a) on interest income recognition does not apply to the forbearances granted under our forbearance program. We will continue to accrue interest on the COVID-19 forbearance granted loans for all such loans that were less than 90 days past due at the forbearance grant date.  We will continue to evaluate the COVID-19 forbearance-granted loans on an individual basis to determine if a reserve should be established on the collectability of the accrued interest and whether any loans should be placed on nonaccrual status at a future date. Approximately $335.1 million or 81% of the $411.2 million loans granted a COVID-19 forbearance were subsequently brought current and the related accrued interest was added to the principal balances of the loans to be repaid by the borrowers upon the earlier of loan payoff or loan maturity.  The deferred loans are considered current at the time of deferral, and the Company continues to accrue interest on the loans.

We made the accounting policy election not to measure an allowance for credit losses for accrued interest receivables. When a loan is placed on nonaccrual status, the accrued and unpaid interest is reversed as a reduction of interest income and accrued interest receivable. Accrued interest receivable is excluded from the amortized cost of loans and it is presented as accrued interest receivable in the Consolidated Balance Sheets.

Deferred Income Tax Assets and Liabilities

Our deferred income tax assets and liabilities arise from differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We determine whether a deferred tax asset is realizable based on facts and circumstances, including our current and projected future tax position, the historical level of our taxable income, and estimates of our future taxable income. In most cases, the realization of deferred tax assets is based on our future profitability. If we were to experience either reduced profitability or operating losses in a future period, the realization of our deferred tax assets may no longer be considered more likely than not and, accordingly, we could be required to record a valuation allowance on our deferred tax assets by charging earnings.

How We Assess Our Business Performance

Net income is the primary metric by which we assess our business performance. Accordingly, we closely monitor the primary drivers of net income which consist of the following:

Net Interest Income

Net interest income is the largest contributor to our net income and is monitored on both an absolute basis and relative to provisions for loan losses and operating expenses. We generate net interest income to the extent that the rate at which we lend in our portfolio exceeds the cost of financing our portfolio, which we primarily achieve through long-term securitizations. Accordingly, we closely monitor the financing markets and maintain consistent dialogue with investors and financial institutions as we evaluate our financing sources and cost of funds.

To evaluate net interest income, we measure and monitor: (1) the yields on our loans, (2) the costs of our funding sources, (3) our net interest spread and (4) our net interest margin. Net interest spread measures the difference between the rates earned on our loans and the rates paid on our funding sources. Net interest margin measures the difference between our annualized interest income and annualized interest expense, or net interest income, as a percentage of average loans outstanding over the specified time period.

Periodic changes in net interest income are primarily driven by: (1) origination volume and changes in average outstanding loan balances and (2) interest rates and changes in interest earned on our portfolio or paid on our debt. Historically, origination volume and portfolio size have been the largest contributors to the growth in our net interest income. We measure net interest income before and after interest expense related to our corporate debt and before and after our provisions for loan losses.

Credit Losses

We strive to minimize actual credit losses through our rigorous screening and underwriting process and life of loan portfolio management and special servicing practices. We closely monitor the credit performance of our loan portfolio, including delinquency rates and expected and actual credit losses, as a key factor in assessing our overall business performance.

Operating Expenses

We incur operating expenses from compensation and benefits related to our employee base, rent and other occupancy costs associated with our leased facilities, our third-party primary loan servicing vendors, professional fees to the extent we utilize third-party legal, consulting and advisory firms, and costs associated with the resolution and disposition of real estate owned, among other items. We monitor and strive to prudently manage operating expenses and to balance current period profitability with investment in the continued development of our platform.  Because volume and portfolio size determine the magnitude of the impact of each of the above factors on our earnings, we also closely monitor origination volume along with all key terms of new loan originations, such as interest rates, loan-to-value ratios, estimated credit losses and expected duration.

Factors Affecting Our Results of Operations

We believe there are a number of factors that impact our business, including those discussed below and in the risk factors disclosed in our Form 10-K for the year ended December 31, 2019 and Form 10-Q for the quarter ended March 31, 2020.

Our results of operations depend on, among other things, the level of our net interest income, the credit performance of our loan portfolio and the efficiency of our operating platform. These measures are affected by a number of factors, including the demand for investor real estate loans, the competitiveness of the market for originating or acquiring investor real estate loans, the cost of financing our portfolio, the availability of funding sources and the underlying performance of the collateral supporting our loans. While we have been successful at managing these elements in the past, there are certain circumstances beyond our control, including the current disruption caused by the COVID-19 pandemic, macroeconomic conditions and market fundamentals, which can affect each of these factors and potentially impact our business performance.

Origination Volume

Portfolio related net interest income is the largest contributor to our net income. We have grown our portfolio related net interest income by $0.5 million or 2.6% from $18.6 million for the quarter ended September 30, 2019 to $19.0 million for the quarter ended September 30, 2020. The growth in net interest income is largely attributable to our growth in loan originations until mid-March 2020, at which time we suspended originations due to the COVID-19 lockdown.

We began accepting new loan applications on September 1^st^ and received applications for $226.0 million in new loans. We closed $8.1 million in new loans in September 30, 2020.

Competition

The investor real estate loan market is highly competitive which could affect our profitability and growth. We believe we compete favorably through diversified borrower access driven by our extensive network of mortgage brokers and by emphasizing a high level of real estate and financial expertise, customer service, and flexibility in structuring transactions, as well as by attracting and retaining experienced managerial and marketing personnel. However, some of our competitors may be better positioned to market their services and financing programs because of their ability to offer more favorable rates and terms and other services.

Availability and Cost of Funding

Our primary funding sources have historically included cash from operations, warehouse repurchase facilities, term securitizations, corporate debt and equity. We believe we have an established brand in the term securitization market and that this market will continue to support our portfolio growth with long-term financing. Changes in macroeconomic conditions can adversely impact our ability to issue securitizations and, thereby, limit our options for long-term financing. In consideration of this potential risk, we have entered into a credit facility for longer-term financing that will provide us with capital resources to fund loan growth in the event we are not able to issue securitizations.

Loan Performance

We underwrite and structure our loans to minimize potential losses. We believe our fully amortizing loan structures and avoidance of large balloon payments, coupled with meaningful borrower equity in properties, limit the probability of losses and that our proven in-house asset management capability allows us to minimize potential losses in situations where there is insufficient equity in the property. Our income is highly dependent upon borrowers making their payments and resolving delinquent loans as favorably as possible. Macroeconomic conditions can, however, impact credit trends in our core market and have an adverse impact on financial results.

Macroeconomic Conditions

The investor real estate loan market may be impacted by a wide range of macroeconomic factors such as interest rates, residential and commercial real estate prices, home ownership and unemployment rates, and availability of credit, among others. We believe our prudent underwriting, conservative loan structures and interest rate protections, and proven in-house asset management capability leave us well positioned to manage changing macroeconomic conditions.

Portfolio and Asset Quality

Key Portfolio Statistics

	September 30, 2020			December 31, 2019			September 30, 2019
	( in thousands)
Total loans				$	2,059,344		$	1,928,208
Loan count					6,373			6,039
Average loan balance				$	323		$	319
Weighted average loan-to-value		%			65.8	%		65.4	%
Weighted average coupon		%			8.69	%		8.71	%
Nonperforming loans (UPB)			(A)	$	141,607		$	118,106
Nonperforming loans (% of total)		%	(A)		6.88	%		6.13	%

All values are in US Dollars.

(A)	Reflects the UPB of loans 90 days or more past due or placed on nonaccrual status. Includes $34.9 million of COVID-19 forbearance-granted loans placed on nonaccrual status as of September 30, 2020.

Total Loans.    Total loans reflects the aggregate UPB at the end of the period. It excludes deferred origination costs, acquisition discounts, fair value adjustments and allowance for credit losses.

Loan Count.     Loan count reflects the number of loans at the end of the period. It includes all loans with an outstanding principal balance.

Average Loan Balance.     Average loan balance reflects the average UPB at the end of the period (i.e., total loans divided by loan count).

Weighted Average Loan-to-Value.     Loan-to-value, or LTV, reflects the ratio of the original loan amount to the appraised value of the underlying property at the time of origination. In instances where the LTV at origination is not available for an acquired loan, the LTV reflects our best estimate of value at the time of acquisition. Weighted average LTV is calculated for the population of loans outstanding at the end of each specified period using the original loan amounts and appraised LTVs at the time of origination of each loan. LTV is a key statistic because requiring the borrower to invest more equity in the collateral minimizes our exposure for future credit losses.

Nonperforming Loans.    Loans that are 90 or more days past due and not included in our COVID-19 forbearance program, in bankruptcy, in foreclosure, or not accruing interest are considered nonperforming loans. The dollar amount of nonperforming loans presented in the table above reflects the UPB of all loans that meet this definition. In the last 7 years, over 90% of our resolved nonperforming loans have either paid current or fully paid off, resulting in a complete recapture of all contractual principal and interest and, in many cases, additional default interest and prepayment fees.

Originations and Acquisitions

The following table presents new loan originations and acquisitions and includes average loan size, weighted average coupon and weighted average loan-to-value for the periods indicated:

($ in thousands)	Loan Count		Loan Balance		Average<br><br><br>Loan Size		Weighted<br><br><br>Average<br><br><br>Coupon			Weighted<br><br><br>Average<br><br><br>LTV
Three Months Ended September 30, 2020:
Loan originations — held for investment		19		8,094		426		7.35	%		68.81	%
Loan originations — held for sale		—		—		—		(—	)%		(—	)%
Total loan originations		19	$	8,094	$	426		7.35	%		68.81	%
Loan acquisitions — held for investment		—		—		—		(—	)%		(—	)%
Total loans originated and acquired		19	$	8,094	$	426		7.35	%		68.81	%
Three Months Ended June 30, 2020:
Loan originations — held for investment		—		—		—		(—	)%		(—	)%
Loan originations — held for sale		—		—		—		(—	)%		(—	)%
Total loan originations		—	$	—	$	—		(—	)%		(—	)%
Loan acquisitions — held for investment		—		—		—		(—	)%		(—	)%
Total loans originated and acquired		—	$	—	$	—		(—	)%		(—	)%
Three Months Ended September 30, 2019:
Loan originations — held for investment		518		183,680		355		8.43	%		68.59	%
Loan originations — held for sale		312		94,559		303		9.87	%		68.74	%
Total loan originations		830		278,239		335		8.92	%		68.64	%
Loan acquisitions — held for investment		1		131		131		7.49	%		75.00	%
Total loans originated and acquired		831		278,370		335		8.92	%		68.65	%

We temporarily suspended our loan originations from late March 2020 through August 2020 due to the dislocation caused by COVID-19. We have resumed loan originations in September 2020.

Loans Held for Investment and Loans Held for Investment at Fair Value

Our total portfolio of loans held for investment consists of both loans held for investment at amortized cost, which are presented in the consolidated financial statements as loans held for investment, net, and loans held for investment at fair value, which are presented in the financial statements as loans held for investment at fair value. The following tables show the various components of loans held for investment as of the dates indicated:

(in thousands)	September 30, 2020			December 31, 2019			September 30, 2019
Unpaid principal balance	$	1,986,344		$	1,843,290		$	1,756,712
Valuation adjustments on FVO loans		(33	)		(444	)		(487	)
Deferred loan origination costs		23,850			25,714			24,756
Total loans held for investment, gross		2,010,161			1,868,560			1,780,981
Allowance for credit losses		(5,748	)		(2,240	)		(2,110	)
Loans held for investment, net	$	2,004,413		$	1,866,320		$	1,778,871

The following table illustrates the contractual maturities for our loans held for investment in aggregate UPB and as a percentage of our total held for investment loan portfolio as of September 30, 2020:

	September 30, 2020
($ in thousands)	UPB		%
Loans due in less than one year	$	86,029		4.3	%
Loans due in one to five years		115,465		5.8	%
Loans due in more than five years		1,784,850		89.9	%
Total loans held for investment	$	1,986,344		100.0	%

Allowance for Credit Losses

Our allowance for credit losses as of September 30, 2020 increased by $0.5 million to $5.7 million from $5.2 million as of June 30, 2020 primarily due to the transfer of our held for sale loan portfolio to our held for investment loan portfolio effective July 1, 2020, offset by the improved macroeconomic forecasts as compared to June 30, 2020. Our allowance for credit losses increased by $3.6 million to $5.7 million as of September 30, 2020, compared to $2.1 million as of September 30, 2019. The $3.6 million increase in allowance for credit losses primarily attributed to the impact on macroeconomic forecasts as a result of COVID-19 coronavirus outbreak, and the transfer of the held for sale loan portfolio. The remaining increase in allowance for credit losses was attributed to the increase in our loan portfolio from September 30, 2019 to September 30, 2020. We strive to minimize actual credit losses through our rigorous screening and underwriting process, life of loan portfolio management and special servicing practices. Additionally, we believe borrower equity of 25% to 40% provides significant protection against credit losses.

To estimate the allowance for credit losses in our loans held for investment portfolio, we follow a detailed internal process, considering a number of different factors including, but not limited to, our ongoing analyses of loans, historical loss rates, relevant environmental factors, relevant market research, trends in delinquencies, effects and changes in credit concentrations, and ongoing evaluation of fair values.

The following table illustrates the activity in our allowance for credit losses over the periods indicated:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2020			2019			2020			2019
Allowance for credit losses:
Beginning balance, prior to adoption of ASC 326	$	5,220		$	2,096		$	2,240		$	1,680
Impact of adopting ASC 326		—			—			137			—
Provision for loan losses (2)		1,574			337			4,663			898
Charge-offs		(1,046	)		(323	)		(1,292	)		(467	)
Ending balance	$	5,748		$	2,110		$	5,748		$	2,111
Total loans held for investment (UPB), excluding FVO (1)	$	1,982,984		$	1,753,289		$	1,982,984		$	1,753,289
% of allowance for credit losses / loans held for investment,<br><br><br>excluding FVO		0.29	%		0.12	%		0.29	%		0.12	%
(1)	Reflects the UPB of loans held for investment excluding loans held for investment at fair value (FVO). Loans held for investment, net on the consolidated balance sheets is net of allowance for credit losses of $5.7 million, and net deferred loan origination fees/costs of $23.9 million as of September 30, 2020.
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(2)	The provision for loans losses would have been approximately $0.4 million and $3.5 million for the three and nine months ended September 30, 2020, respectively, excluding the $1.2 million impact from the loans held for sale transferred to loans held for investment. The additional $1.2 million provision was mainly offset by the reversal of the $1.3 million valuation allowance on the held for sale loans, which was recorded to “Other income” in the consolidated statements of income.
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Credit Quality – Loans Held for Investment and Loans Held for Investment at Fair Value

The following table provides delinquency information on our loans held for investment and loans held for investment at fair value by UPB as of the dates indicated:

	September 30, 2020 (A)				COVID-19<br><br><br>Forbearance		June 30, 2020 (A)					COVID-19<br><br><br>Forbearance		September 30, 2019
Performing/Accruing:
Current	$	1,474,076	74.2	%	$	266,446	$	1,186,267		64.3	%	$	11,545	$	1,509,537	85.9	%
30-59 days past due		108,601	5.5			42,609		121,320		6.6			36,889		110,484	6.3
60-89 days past due		74,351	3.7			52,636		145,976		7.9			99,774		34,729	2.0
90+ days past due		14,589	0.7			14,590		122,195		6.6			122,195		—	—
Nonperforming/Nonaccrual:
<90 days past due		23,502	1.2			603		18,657		1.0			5,957		—	—
90+ days past due		119,248	6.0			31,546		136,577		7.4			12,397		20,894	1.2
Bankruptcy		8,646	0.4			1,620		8,668		0.5			—		9,626	0.5
In foreclosure		163,331	8.2			1,114		104,947		5.7			770		71,441	4.1
Total nonperforming loans		314,727	15.8			34,883		268,849	(1)	14.6			19,124		101,961	5.8
Total loans held for investment	$	1,986,344	100.0	%	$	411,164	$	1,844,607		100.0	%	$	289,527	$	1,756,711	100.0	%
(A)	Balance includes the UPB of loans held for investment in our COVID-19 forbearance program.
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(1)	Nonperforming loans of $268.8 million as of June 30, 2020 excluded $60.3 million nonperforming loans held for sale.
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Other than loans in the COVID-19 forbearance program, loans that are 90+ days past due, in bankruptcy, in foreclosure, or not accruing interest are considered nonperforming loans. Nonperforming loans were $314.7 million or 15.8% of our held for investment loan portfolio as of September 30, 2020, compared to $268.8 million, or 14.6% as of June 30, 2020, and $102.0 million, or 5.8% of the held for investment loan portfolio as of September 30, 2019. The increase in total nonperforming loans as of September 30, 2020 was primarily attributed to the COVID-19 pandemic, and the increase in the held for investment loan portfolio from the transfer of held for sale loan portfolio. We believe the significant equity cushion at origination and the active management of loans will continue to minimize credit losses on the resolution of defaulted loans and disposition of REO properties.

Historically, most loans that become nonperforming resolve prior to converting to REO. This is due to low LTVs at origination and our active management of the portfolio. The following table summarizes the resolution activities of loans that became nonperforming prior to the beginning of the periods indicated or became nonperforming and subsequently resolved during the quarter. Of the $329.1 million nonperforming loans as of June 30, 2020, we resolved $10.9 million, or 3.3% during the quarter ended September 30, 2020. During the quarter ended September 30, 2019, we resolved $22.7 million, or 20.3% of the $112.1 million nonperforming loans as of June 30, 2019. Including REO resolutions, we realized net gains of $0.4 million and $0.8 million during the quarter ended September 30, 2020 and 2019, respectively. This is largely the result of collecting default interest and prepayment penalties in excess of the contractual interest due and collected.

	Three Months Ended September 30, 2020								Three Months Ended September 30, 2019
($ in thousands)	UPB		% of<br><br><br>Nonperforming<br><br><br>UPB			Gain /<br><br><br>(Loss)			UPB		% of<br><br><br>Nonperforming<br><br><br>UPB			Gain /<br><br><br>(Loss)
Nonperforming UPB, beginning of<br><br><br>period	$	329,132							$	112,073
Resolved — paid in full		9,705		2.9	%	$	728			11,637		10.38	%	$	751
Resolved — paid current		1,152		0.4	%		24			11,074		9.88	%		84
Resolved — REO sold		1,628					(312	)		1,262					(85	)
Total resolutions	$	12,485		3.3	%	$	440		$	23,973		20.3	%	$	750
Recovery rate on resolved<br><br><br>nonperforming UPB							103.5	%							103.1	%

Our actual losses incurred have been small as a percentage of nonperforming loans held for investment. The table below shows our actual loan losses for the periods indicated.

	Three Months Ended				Three Months Ended				Year Ended
($ in thousands)	September 30, 2020				June 30, 2020				December 31, 2019
Average nonperforming loans for the period (1)		311,136				289,940				111,427
Charge-offs		1,046				76				579
Charge-offs / Average nonperforming loans for the period (1)		0.55	%	(2)		0.17	%	(2)		0.52	%
(1)	Reflects the monthly average of nonperforming loans held for investment during the period.
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(2)	Reflects annualized year-to-date charge-offs to average nonperforming loans for the period.
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Concentrations – Loans Held for Investment

As of September 30, 2020, our held for investment loan portfolio was concentrated in investor 1-4 loans, representing 50.7% of the UPB. Mixed used properties represented 12.8% of the UPB. No other property type represented more than 10.0% of our held for investment loan portfolio. By geography, the principal balance of our loans held for investment were concentrated 23.2% in California, 22.7% in New York, 11.7% in Florida, and 8.0% in New Jersey.

Property Type	September 30, 2020
($ in thousands)	Loan Count		UPB		% of Total UPB
Investor 1-4		3,675	$	1,007,560		50.7	%
Mixed use		668		254,486		12.8
Multifamily		445		187,105		9.4
Retail		400		172,775		8.7
Office		273		110,455		5.6
Warehouse		202		117,910		5.9
Other(1)		366		136,053		6.8
Total loans held for investment		6,029	$	1,986,344		100	%
(1)	All other properties individually comprise less than 5.0% of the total unpaid principal balance.
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Geography (State)	September 30, 2020
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($ in thousands)	Loan Count		UPB		% of Total UPB
New York	957		$	451,105		22.7	%
California	935			461,322		23.2
Florida	830			231,778		11.7
New Jersey	629			159,456		8.0
Other(1)		2,678		682,683		34.4
Total loans held for investment		6,029	$	1,986,344		100	%
(1)	All other states individually comprise less than 5.0% of the total unpaid principal balance.
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Loans Held for Sale

We started originating short-term, interest-only loans in March 2017, which we had historically aggregated and sold at a premium to par to institutional investors. The held for sale loans were carried at the lower of cost or estimated fair value. Effective July 1, 2020, the loans held for sale portfolio with unpaid principal balance of $214.4 million were transferred to the held for investment loan portfolio. The related valuation allowance of $1.3 million on these loans were reversed through earnings. We had no loans held for sale as of September 30, 2020.

The following tables show the various components of loans held for sale as of the dates indicated:

($ in thousands)	September 30, 2020		December 31, 2019
UPB	$	—	$	216,054
Valuation adjustments		—		(396	)
Deferred loan origination fees, net		—		(1,191	)
Total loans held for sale, net	$	—	$	214,467

Real Estate Owned (REO)

REO includes real estate we acquire through foreclosure or by deed-in-lieu of foreclosure. REO assets are initially recorded at fair value, less estimated costs to sell, on the date of foreclosure. Adjustments that reduce the carrying value of the loan to the fair value of the real estate at the time of foreclosure are recognized as charge-offs in the allowance for credit losses. Positive adjustments at the time of foreclosure are recognized in other operating income. After foreclosure, we periodically obtain new valuations and any subsequent changes to fair value, less estimated costs to sell, are reflected as valuation adjustments.

As of September 30, 2020, our REO included 27 properties with an estimated fair value of $14.7 million compared to 24 properties with an estimated fair value of $13.1 million as of December 31, 2019.

Key Performance Metrics

	Three Months Ended
($ in thousands)	September 30, 2020 (1)			June 30, 2020 (1)			September 30, 2019 (1)
Average loans	$	2,016,414		$	2,095,307		$	1,826,141
Portfolio yield		8.21	%		7.59	%		8.84	%
Average debt — portfolio related		1,764,975			1,831,867			1,648,462
Average debt — total company		1,842,975			1,909,867			1,785,344
Cost of funds — portfolio related		5.07	%		4.63	%		5.30	%
Cost of funds — total company		5.27	%		4.83	%		5.75	%
Net interest margin — portfolio related		3.77	%		3.54	%		4.06	%
Net interest margin — total company		3.39	%		3.18	%		3.22	%
Charge-offs		0.05	%		0.00	%		0.02	%
Pre-tax return on equity		9.60	%		4.94	%		15.38	%
Return on equity		6.65	%		4.03	%		10.52	%
(1)	Percentages are annualized.
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Average Loans

Average loans reflects the daily average of total outstanding loans, including both loans held for investment and loans held for sale, as measured by UPB, over the specified time period.

Portfolio Yield

Portfolio yield is an annualized measure of the total interest income earned on our loan portfolio as a percentage of average loans over the given period. Interest income includes interest earned on performing loans, cash interest received on nonperforming loans, default interest and prepayment fees. The fluctuations in our portfolio yield over the periods shown was primarily driven by loans placed on non-accrual status during the periods.

Average Debt — Portfolio Related and Total Company

Portfolio-related debt consists of borrowings related directly to financing our loan portfolio, which includes our warehouse repurchase facilities and securitizations. Total company debt consists of portfolio- related debt and corporate debt. The measures presented here reflect the monthly average of all portfolio- related and total company debt, as measured by outstanding principal balance, over the specified time period.

Cost of Funds — Portfolio Related and Total Company

Our portfolio related cost of funds increased to 5.07% for the three months ended September 30, 2020 from 4.63% for the three months ended June 30, 2020 and improved from 5.30% for the three months ended September 30, 2019. The increase in portfolio related cost of funds quarter over quarter was the result of higher spreads paid to investors in our more recent securitizations during the COVID-19 pandemic.

Portfolio related cost of funds is an annualized measure of the interest expense incurred on our portfolio-related debt as a percentage of average portfolio-related debt outstanding over the given period. Total company cost of funds is an annualized measure of the interest expense incurred on our portfolio-related debt and corporate debt outstanding over the given period. Interest expense includes the amortization of expenses incurred in connection with our portfolio related financing activities and corporate debt.

Through the issuance of long-term securitizations, we have been able to fix a significant portion of our borrowing costs over time. The strong credit performance on our securitizations has allowed us to issue debt at attractive rates.

Net Interest Margin — Portfolio Related and Total Company

Portfolio related net interest margin measures the difference between the interest income earned on our loan portfolio and the interest expense paid on our portfolio-related debt as a percentage of average loans over the specified time period. Total company net interest margin measures the difference between the interest income earned on our loan portfolio and the interest expense paid on our portfolio-related debt and corporate debt as a percentage of average loans over the specified time period.

Over the periods shown below, our portfolio related net interest margin decreased from September 2019 to June 2020 mainly as a result of increased nonperforming loans due to the COVID-19 pandemic and, to a lesser extent, the seasoning of our loan portfolio. Our portfolio related net interest margin increased from June 2020 to September 2020 mainly due to the decrease in loans becoming nonaccrual during the three months ended September 30, 2020 as compared the three months ended June 30, 2020.

Our total company net interest margin increased from 3.18% for the three months ended June 30, 2020 to 3.39% for the three months ended September 30, 2020 as a result of COVID-19 loan deferrals where we recorded the related interest income during the three months ended September 30, 2020.

The following tables show the average outstanding balance of our loan portfolio and portfolio-related debt, together with interest income and the corresponding yield earned on our portfolio, and interest expense and the corresponding rate paid on our portfolio-related debt for the periods indicated:

	Three Months Ended
	September 30, 2020							June 30, 2020							September 30, 2019
			Interest		Average					Interest		Average					Interest		Average
	Average		Income /		Yield /			Average		Income /		Yield /			Average		Income /		Yield /
($ in thousands)	Balance		Expense		Rate (1)			Balance		Expense		Rate (1)			Balance		Expense		Rate (1)
Loan portfolio:
Loans held for sale	$	—						$	220,047						$	122,763
Loans held for investment		2,016,414							1,875,260							1,703,377
Total loans	$	2,016,414	$	41,374		8.21	%	$	2,095,307	$	39,755		7.59	%	$	1,826,140	$	40,379		8.84	%
Debt:
Warehouse and repurchase facilities	$	22,306		703		12.61	%	$	242,676		2,632		4.34	%	$	246,532	$	3,527		5.72	%
Securitizations		1,742,669		21,644		4.97	%		1,589,191		18,557		4.67	%		1,401,930		18,300		5.22	%
Total debt - portfolio related		1,764,975		22,347		5.07	%		1,831,867		21,189		4.63	%		1,648,462		21,827		5.30	%
Corporate debt		78,000		1,913		9.81	%		78,000		1,894		9.71	%		136,882		3,842		11.23	%
Total debt	$	1,842,975	$	24,260		5.27	%	$	1,909,867	$	23,083		4.83	%	$	1,785,344	$	25,669		5.75	%
Net interest spread -<br><br><br>portfolio related (2)						3.14	%						2.96	%						3.55	%
Net interest margin -<br><br><br>portfolio related						3.77	%						3.54	%						4.06	%
Net interest spread -<br><br><br>total company (3)						2.94	%						2.75	%						3.09	%
Net interest margin -<br><br><br>total company						3.39	%						3.18	%						3.22	%
(1)	Annualized.
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(2)	Net interest spread — portfolio related is the difference between the rate earned on our loan portfolio and the interest rates paid on our portfolio-related debt.
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(3)	Net interest spread — total company is the difference between the rate earned on our loan portfolio and the interest rates paid on our total debt.
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Charge-Offs

Our annualized charge-off rate for the three months ended September 30, 2020 and June 30, 2020 remained low at 0.55% and 0.17%, respectively. The charge-offs rate reflects year-to-date annualized charge-offs as a percentage of average nonperforming loans held for investment for the respective quarter. We do not record charge-offs on our loans held for sale which are carried at the lower of cost or estimated fair value.

Pre-Tax Return on Equity and Return on Equity

Pre-tax return on equity and return on equity reflect income before income taxes and net income, respectively, as a percentage of the monthly average of stockholders/members’ equity over the specified time period.

	Three Months Ended
($ in thousands)	September 30, 2020			June 30, 2020			September 30, 2019
Income before income taxes (A)	$	5,025		$	2,625		$	5,676
Net income (B)		3,481			2,141			3,880
Monthly average balance:
Stockholders' / Members' equity (C)		209,468			212,407			147,579
Pre-tax return on equity (A)/(C) (1)		9.6	%		4.9	%		15.4	%
Return on equity (B)/(C) (1)		6.6	%		4.0	%		10.5	%
(1)	Annualized.
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Components of Results of Operations

Interest Income

We accrue interest on the UPB of our loans in accordance with the individual terms and conditions of each loan, discontinuing interest and reversing previously accrued interest once a loan becomes 90 days or more past due (nonaccrual status). When a loan is placed on nonaccrual status, the accrued and unpaid interest is reversed as a reduction to interest income and accrued interest receivable. Interest income is subsequently recognized only to the extent that cash payments are received or when the loan has returned to accrual status. Payments received on nonaccrual loans are first applied to interest due, then principal. Interest accrual resumes once a borrower has made all principal and interest payments due, bringing the loan back to current status.

In response to the COVID-19 pandemic, we implemented a COVID-19 forbearance program allowing customers to primarily defer payments for up to 90 days. We will continue to accrue interest on loans in the COVID-19 forbearance program that were less than 90 days past due at forbearance grant date. We will continue to evaluate the COVID-19 forbearance-granted loans on an individual basis to determine if a reserve should be established on the collectability of the accrued interest and whether any loans should be placed on nonaccrual status at a future date. Approximately $335.1 million or 81% of the $411.2 million loans granted a COVID-19 forbearance were subsequently brought current and the related accrued interest was added to the principal balances of the loans to be repaid by the borrowers upon the earlier of loan payoff or loan maturity. The deferred loans are considered current at the time of deferral, and the Company continues to accrue interest on the loans.

Interest income on loans held for investment is comprised of interest income on loans and prepayment fees less the amortization of deferred net costs related to the origination of loans. Interest income on loans held for sale is comprised of interest income earned on loans prior to their sale. The net fees and costs associated with loans held for sale are deferred as part of the carrying value of the loan and recognized as a gain or loss on the sale of the loan.

Interest Expense — Portfolio Related

Portfolio related interest expense is incurred on the debt we incur to fund our loan origination and portfolio activities and consists of our warehouse repurchase facilities and securitizations. Portfolio related interest expense also includes the amortization of expenses incurred as a result of issuing the debt, which are amortized using the level yield method. Key drivers of interest expense include the debt amounts outstanding, interest rates, and the mix of our securitizations and warehouse liabilities.

Net Interest Income — Portfolio Related

Portfolio related net interest income represents the difference between interest income and portfolio related interest expense.

Interest Expense — Corporate Debt

Interest expense on corporate debt primarily consists of interest expense paid with respect to the 2019 Term Loan, as reflected on our consolidated statement of financial condition, and the related amortization of deferred debt issuance costs.

Net Interest Income

Net interest income represents the difference between portfolio related net interest income and interest expense on corporate debt.

Provision for Loan Losses

Provision for loan losses consists of amounts charged to income during the period to maintain an estimated allowance for credit losses, or ACL, to provide for credit losses inherent in our existing portfolio of loans held for investment (excluding those loans which we have elected to carry at fair value). The ACL consists of an allowance on loans that are assessed or evaluated individually, and an allowance for loans evaluated collectively by segment. Loans 90 days or more delinquent, in bankruptcy, or in foreclosure, are evaluated individually, and these loans are excluded from loans evaluated collectively by segment.

Other Operating Income

Gain on Disposition of Loans.    When we sell a loan held for sale, we record a gain or loss that reflects the difference between the proceeds received for the sale of the loans and their respective carrying values. The gain or loss that we ultimately realize on the sale of our loans held for sale is primarily determined by the terms of the originated loans, current market interest rates and the sales price of the loans. In addition, when we transfer a loan to REO, we record the REO at its fair value at the time of the transfer. The difference between the fair value of the real estate and the carrying value of the loan is recorded as a gain or loss. Lastly, when our acquired loans, which were purchased at a discount, pay off, we record a gain related to the write-off of the remaining purchase discount.

Unrealized Gain/(Loss) on Fair Value Loans.     We have elected to account for certain purchased distressed loans at fair value using FASB ASC Topic 825, Financial Instruments (ASC 825). We regularly estimate the fair value of these loans as discussed more fully in the notes to our consolidated financial statements. Changes in fair value subsequent to initial recognition of fair value loans are reported as unrealized gain/(loss) on fair value loans, a component of other operating income within the consolidated statements of operations.

Other Income.     Other income includes the following:

Unrealized Gains/(Losses) on Retained Interest Only Securities.     As part of the proceeds received for the sale of our held for sale loans, we may receive an interest only security. Changes in fair value subsequent to initial recognition are reported as unrealized gains/(losses) on interest-only securities.

Valuation Allowance on Loans Held for Sale.Loans held for sale are carried at the lower of cost or estimated fair value (“LOCOM). Adjustments to the carrying value of loans held for sale to estimate fair value are reported as valuation allowance.

Fee Income.     In certain situations, we collect fee income by originating loans and realizing miscellaneous fees.

Operating Expenses

Compensation and Employee Benefits.     Costs related to employee compensation, commissions and related employee benefits, such as health, retirement, and payroll taxes.

Rent and Occupancy.     Costs related to occupying our locations, including rent, maintenance and property taxes.

Loan Servicing.     Costs related to our third-party servicers.

Professional Fees.     Costs related to professional services, such as external audits, legal fees, tax, compliance and outside consultants.

Real Estate Owned, Net.     Costs related to our real estate owned, net, including gains/(losses) on disposition of REO, maintenance of REO properties, and taxes and insurance.

Other Operating Expenses.     Other operating expenses consist of general and administrative costs such as, travel and entertainment, marketing, data processing, insurance and office equipment.

Provision for Income Taxes

The provision for income taxes consists of the current and deferred U.S. federal and state income taxes we expect to pay, currently and in future years, with respect to the net income for the year. The amount of the provision is derived by adjusting our reported net income with various permanent differences. The tax- adjusted net income amount is then multiplied by the applicable federal and state income tax rates to arrive at the provision for income taxes.

Consolidated Results of Operations

The following table summarizes our consolidated results of operations for the periods indicated:

	Three Months Ended						Nine Months Ended
($ in thousands)	September 30, 2020			September 30, 2019			September 30, 2020		September 30, 2019
Interest income	$	41,374		$	40,379		$	125,766	$	113,407
Interest expense - portfolio related		22,347			21,827			66,384		61,214
Net interest income - portfolio related		19,027			18,552			59,382		52,193
Interest expense - corporate debt		1,913			3,842			10,149		10,548
Net interest income		17,114			14,710			49,233		41,645
Provision for loan losses		1,573			338			4,662		898
Net interest income after provision for loan losses		15,541			14,372			44,571		40,747
Other operating income		1,349	(1)		(212	)		1,628		1,817
Total operating expenses		11,865			8,484			34,823		25,308
Income before income taxes		5,025			5,676			11,376		17,256
Income tax expense		1,544			1,796			3,175		5,146
Net income	$	3,481		$	3,880		$	8,201	$	12,110
(1)	Included in other operating income for the three months ended September 30, 2020 was the $1.3 million reversal of valuation allowance on loans held for sale upon transfer to loans held for investment.
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Net Interest Income — Portfolio Related

	Three Months Ended September 30,					Nine Months Ended September 30,
($ in thousands)	2020		2019		Change	2020		2019		Change
Interest income	$	41,374	$	40,379		$	125,766	$	113,407
Interest expense - portfolio related		22,347		21,827			66,384		61,214
Net interest income - portfolio related	$	19,027	$	18,552		$	59,382	$	52,193

All values are in US Dollars.

Portfolio related net interest income is the largest contributor to our net income. For the nine months ended September 30, 2020, we increased our portfolio related net interest income by $7.2 million over the prior year period. We grew our portfolio related net interest income by $0.5 million from $18.6 million for the three months ended September 30, 2019 to $19.0 million for the three months ended September 30, 2020. The growth was due to the increase in originations in the last nine months of 2019 and the first quarter of 2020, prior to the COVID-19 crisis. The pandemic caused a temporary suspension in originations starting in late March 2020 that continued until September 2020.

Interest Income.     Interest income increased by $12.4 million for the nine months ended September 30, 2020 over the prior year period and by $1.0 million to $41.4 million for the three months ended September 30, 2020, compared to $40.4 million for the three months ended September 30, 2019. The increase is primarily attributable to an increase in average loans, which increased $190.3 million from $1.8 billion for the three months ended September 30, 2019 to $2.0 billion for the three months ended September 30, 2020. The average yield over those same periods decreased from 8.84% to 8.21% mainly due to the increase in nonperforming loans due to the COVID-19 pandemic.

The following tables distinguish between the change in interest income attributable to change in volume and the change in interest income attributable to change in rate for the three months ended September 30, 2020 and June 30, 2020, and the three and nine months ended September 30, 2020 and 2019, respectively. The effect of changes in volume is determined by multiplying the change in average loan balance by the previous period’s average yield. The effect of rate changes is calculated by multiplying the change in average yield by the current period’s average loan balance.

	Three Months Ended September 30, 2020 and June 30, 2020
($ in thousands)	Average<br><br><br>Loans			Interest<br><br><br>Income			Average<br><br><br>Yield (1)
Three months ended September 30, 2020	$	2,016,414		$	41,374			8.21	%
Three months ended June 30, 2020		2,095,307			39,755			7.59	%
Volume variance		(78,893	)		(1,497	)
Rate variance					3,116			0.62	%
Total interest income variance				$	1,619
(1)  Annualized.
	Three Months Ended September 30, 2020 and 2019
---	---	---	---	---	---	---	---	---
($ in thousands)	Average<br><br><br>Loans		Interest<br><br><br>Income			Average<br><br><br>Yield (1)
Three months ended September 30, 2020	$	2,016,414	$	41,374			8.21	%
Three months ended September 30, 2019		1,826,141		40,379			8.84	%
Volume variance		190,273		4,207
Rate variance				(3,212	)		(0.63	)%
Total interest income variance			$	995
(1)  Annualized.
	Nine Months Ended September 30, 2020 and 2019
---	---	---	---	---	---	---	---	---
($ in thousands)	Average<br><br><br>Loans		Interest<br><br><br>Income			Average<br><br><br>Yield (1)
Nine months ended September 30, 2020	$	2,065,168	$	125,766			8.12	%
Nine months ended September 30, 2019		1,715,235		113,407			8.82	%
Volume variance		349,933		41,132
Rate variance				(28,773	)		(0.70	)%
Total interest income variance			$	12,359
(1)  Annualized.

Interest Expense — Portfolio Related.    Portfolio related interest expense consists of interest incurred on our warehouse facilities and securitizations, which increased by 0.44% to 5.07% for the three months ended September 30, 2020 from 4.63% for the three months ended June 30, 2020 as a result of more expensive recent 2020 securitizations. The $0.5 million increase from $21.8 million for the three months ended September 30, 2019 to $22.3 million for the three months ended September 30, 2020 was primarily attributable to the increase in securitizations financing increased loan volume, offset by the decrease in cost of funds which decreased to 5.07% for the three months ended September 30, 2020 from 5.30% for the three months ended September 30, 2019.

The following tables present information regarding the portfolio related interest expense and distinguishes between the dollar amount of change in interest expense attributable to changes in the average outstanding debt balance (volume) versus changes in cost of funds (rate) for the three months ended September 30, 2020 and June 30, 2020, and the three and nine months ended September 30, 2020 and 2019, respectively.

	Three Months Ended September 30, 2020 and June 30, 2020
($ in thousands)	Average<br><br><br>Debt (1)			Interest<br><br><br>Expense			Cost of<br><br><br>Funds (2)
Three months ended September 30, 2020	$	1,764,975		$	22,347			5.07	%
Three months ended June 30, 2020		1,831,867			21,189			4.63	%
Volume variance		(66,892	)		(774	)
Rate variance					1,932			0.44	%
Total interest expense variance				$	1,158
(1)   Includes securitizations and warehouse repurchase agreements.
(2)  Annualized.
	Three Months Ended September 30, 2020 and 2019
---	---	---	---	---	---	---	---	---
($ in thousands)	Average<br><br><br>Debt (1)		Interest<br><br><br>Expense			Cost of<br><br><br>Funds (2)
Three months ended September 30, 2020	$	1,764,975	$	22,347			5.07	%
Three months ended September 30, 2019		1,648,462		21,827			5.30	%
Volume variance		116,513		1,543
Rate variance				(1,023	)		(0.23	)%
Total interest expense variance			$	520
(1)   Includes securitizations and warehouse repurchase agreements.
(2)  Annualized.
	Nine Months Ended September 30, 2020 and 2019
---	---	---	---	---	---	---	---	---
($ in thousands)	Average<br><br><br>Debt (1)		Interest<br><br><br>Expense			Cost of<br><br><br>Funds (2)
Nine months ended September 30, 2020	$	1,828,836	$	66,384			4.84	%
Nine months ended September 30, 2019		1,529,009		61,214			5.34	%
Volume variance		299,827		21,340
Rate variance				(16,170	)		(0.50	)%
Total interest expense variance			$	5,170
(1)   Includes securitizations and warehouse repurchase agreements.
(2)  Annualized.

Net Interest Income After Provision for Loan Losses

	Three Months Ended September 30,						Nine Months Ended September 30,
($ in thousands)	2020		2019		Change		2020		2019		Change
Net interest income - portfolio related	$	19,027	$	18,552			$	59,382	$	52,193
Interest expense - corporate debt		1,913		3,842		)		10,149		10,548		)
Net interest income		17,114		14,710				49,233		41,645
Provision for loan losses		1,573		338				4,662		898
Net interest income after provision for loan losses	$	15,541	$	14,372			$	44,571	$	40,747

All values are in US Dollars.

Interest Expense — Corporate Debt.     Corporate debt interest expense decreased by $1.9 million from $3.8 million for the three months ended September 30, 2019 to $1.9 million for the three months ended September 30, 2020 primarily due to the $75.0 million principal paydown with IPO proceeds in January 2020. Corporate debt interest expense decreased by $0.4 million in the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019 primarily due to the lower outstanding balances in 2020, offset by the one-time amortization of $3.5 million debt issuance costs and $0.3 million prepayment fees paid in January 2020 as a result of a $75 million debt principal paydown with IPO proceeds.

Provision for Loan Losses.      Our provision for loan losses increased from $0.3 million for the three months ended September 30, 2019 to $1.6 million for the three months ended September 30, 2020, of which $1.2 million of the increase was due to the one-time transfer of our held for sale loan portfolio to our held for investment loan portfolio. The transfer resulted in a reversal of the previous valuation allowance, which increased Other Operating Income by $1.3 million. The provision for loan losses increased by $3.8 million from $0.9 million for the nine months ended September 30, 2019 to $4.7 million for the nine months ended September 30, 2020, of which $1.2 million of the increase was due to the one-time transfer of our held for sale loan portfolio and the remainder was attributable to the adverse business conditions caused by the COVID-19 pandemic assumed in our loan loss model projections.

Other Operating Income

The $1.6 million increase from an expense of $0.2 million for the three months ended September 30, 2019 to income of $1.4 million for the three months ended September 30, 2020 was driven mainly by one-time transfer of our held for sale loan portfolio to our held for investment loan portfolio. The $0.2 million decrease from $1.8 million for the nine months ended September 30, 2019 to $1.6 million for the nine months ended September 30, 2020 is primarily due to higher unrealized loss on securities.

	Three Months Ended September 30,								Nine Months Ended September 30,
($ in thousands)	2020			2019			Change		2020			2019			Change
Gain on disposition of loans	$	(51	)	$	56			)	$	2,721		$	2,914			)
Unrealized gain on fair value loans		379			(18	)				411			(51	)
Other (expense) income		1,021			(250	)				(1,504	)		(1,046	)		)
Total other operating income	$	1,349		$	(212	)			$	1,628		$	1,817			)

All values are in US Dollars.

Operating Expenses

Total operating expenses increased by $3.4 million to $11.9 million for the three months ended September 30, 2020 from $8.5 million for three months ended September 30, 2019. For nine months ended September 30, 2020, total operating expenses increased by $9.5 million compared to the same period in 2019. The increases are primarily attributable to direct loan origination costs included in the Compensation and Servicing lines in the table below that were deferred in 2019 in accordance with U.S. GAAP and amortized over the lives of new loan originations but were expensed in 2020 due to the suspension of loan production.

	Three Months Ended September 30,					Nine Months Ended September 30,
($ in thousands)	2020		2019		Change	2020		2019		Change
Compensation and employee benefits	$	5,692	$	3,712		$	16,595	$	11,519
Rent and occupancy		415		369			1,319		1,105
Loan servicing		2,168		1,957			5,825		5,457
Professional fees		1,051		398			2,823		1,587
Real estate owned, net		898		485			2,439		1,348
Other operating expenses		1,641		1,563			5,822		4,292
Total operating expenses	$	11,865	$	8,484		$	34,823	$	25,308

All values are in US Dollars.

Compensation and Employee Benefits.    Compensation and employee benefits increased from $3.7 million for the three months ended September 30, 2019 to $5.7 million for the three months ended September 30, 2020; and increased from $11.5 million for the nine months ended September 30, 2019 to $16.6 million for the nine months ended September 30, 2020 primarily due to the recognition of all compensation expenses in the current year periods, whereby in 2019 we deferred some direct origination expenses associated with new originations. In addition, we expensed a one-time severance payment of $0.6 million in September 2020 as a result of the staff reduction caused by the COVID-19 pandemic.

Rent and Occupancy.    Rent and occupancy expenses slightly increased for the t h r e e   m on t h s   e  n d ed   S e p t e m b e r   3 0, 2 0 2 0  compared to the three months ended September 30, 2019. The $0.2 million increase to $1.3 million for the nine months ended September 30, 2020 compared to the same period in 2019 is due to an increase in office space.

Loan Servicing.     Loan servicing expenses increased from $2.0 million for the three months ended September 30, 2019 to $2.2 million for the three months ended September 30, 2020; and increased from $5.5 million for the nine months ended September 30, 2019 to $5.8 million for the nine months ended September 30, 2020 due to the increase in our loan portfolio.

Professional Fees.     Professional fees increased from $0.4 million for the three months ended September 30, 2019 to $1.1 million for the three months ended September 30, 2020; and increased from $1.6 million for the nine months ended September 30, 2019 to $2.8 million for the nine months ended September 30, 2020 mainly due to our growth and increased costs as a public company.

Net Expenses of Real Estate Owned.     Net expenses of real estate owned increased from $0.5 million for the three months ended September 30, 2019 to $0.9 million for the three months ended September 30, 2020; and increased from $1.3 million for the nine months ended September 30, 2019 to $2.4 million for the nine months ended September 30, 2020 mainly due to higher valuation adjustments, partially offset by higher gains on sale and rental income.

Other Operating Expenses.     Other operating expenses remained consistent at approximately $1.6 million for the three months ended September 30, 2019 and 2020. Other operating expense increased from $4.3 million for the nine months ended September 30, 2019 to $5.8 million for the nine months ended September 30, 2020, primarily due to the increase in directors’ and officers’ insurance expenses related to becoming a publicly traded company, as well as SEC filing fees.

Income Tax Expense.    Income tax expense was $1.5 million and $1.8 million for the three months ended September 30, 2020 and 2019 and $3.2 million and $5.1 million for the nine months ended September 30, 2020 and 2019, respectively. Our consolidated effective tax rate as a percentage of pre-tax income was 30.7% and 31.6% for the three months ended September 30, 2020 and 2019, and 27.9% and 29.8% for the nine months ended September 30, 2020 and 2019, respectively. The effective tax rate for the three and nine months ended September 30, 2020 were lower compared to the same periods in 2019 due to an interest reserve for an uncertain tax position in 2019 which increased the effective tax rate.

Liquidity and Capital Resources

Sources and Uses of Liquidity

We fund our lending activities primarily through borrowings under our warehouse facilities, securitizations, other corporate-level debt, equity, debt securities, and net cash provided by operating activities to manage our business. We use cash to originate and acquire investor real estate loans, repay principal and interest on our borrowings, fund our operations and meet other general business needs.

•	On September 30, 2020 we extended and amended the 2013 repurchase agreement in the amount of $100 million. The amended agreement has an extended maturity of September 29, 2021 and has a modified mark-to-market provision which helps us manage risk.

Cash and Cash Equivalents

We had cash of $19.2 million and $8.8 million as of September 30, 2020 and 2019, respectively. The following table summarizes the net cash provided by (used in) operating activities, investing activities and financing activities as of the periods indicated:

	Nine Months Ended
($ in thousands)	September 30, 2020			September 30, 2019
Cash provided by (used in):
Operating activities	$	37,364		$	(77,193	)
Investing activities		73,339			(219,034	)
Financing activities		(111,224	)		291,551
Net change in cash, cash equivalents, and restricted cash	$	(521	)	$	(4,676	)

Cash flows from operating activities primarily includes net income adjusted for (1) cash used for origination of held for sale loans and the related cash proceeds from the sales of such loans, (2) non-cash items including depreciation, provision for loan loss, discount accretion, and valuation changes, and (3) changes in the balances of operating assets and liabilities.

For the nine months ended September 30, 2020, our net cash provided by operating activities consisted mainly of $80.9 million in cash proceeds from sales of held for sale loans and $19.9 million in cash received from repayments on held for sale loans, partially offset by $96.1 million in cash used to originate held for sale loans.

For the nine months ended September 30, 2020, our net cash provided by investing activities consisted mainly of $161.8 million in cash used to originate held for investment loans, offset by $242.2 million in cash received in payments on held for investment loans.

For the nine months ended September 30, 2020, our net cash used in financing activities consisted mainly of $267.5 million and $518.0 million in cash from borrowings from our warehouse repurchase facilities and securitizations issued, respectively; net proceeds from IPO of $100.8 million; and net proceeds from issuance of preferred stock of $41.0 million. The cash generated was partially offset by payments we made of $670.4 million and $284.9 million on our warehouse repurchase facilities and securitizations issued, respectively.

During the nine months ended September 30, 2020, we used approximately $0.5 million of net cash and cash equivalents in operations, investing and financing activities. During nine months ended September 30, 2019, we used approximately $4.7 million of net cash and cash equivalents in operations, investing and financing activities.

Warehouse and Repurchase Facilities

As of September 30, 2020, we had one short term warehouse repurchase agreement to finance loans pending securitization. The borrowings are collateralized by primarily performing loans, bearing interest at one-month LIBOR plus 3.25%. Borrowing under this repurchase facility was $6.5 million as of September 30, 2020. Borrowing under two previous facilities was $417.2 million as of December 31, 2019.

In addition to the warehouse repurchase agreement, we also have a longer term warehouse agreement, which was added in September 2018. The borrowings are collateralized by pools of primarily performing loans, with a maximum borrowing capacity of $50.0 million, bearing interest at one-month LIBOR plus a margin of 3.50%. The warehouse agreement has a maturity date of September 12, 2021 and allows loans to be financed for a period of up to three years. Borrowings under this warehouse agreement were zero and $2.5 million as of September 30, 2020 and December 31, 2019, respectively.

All warehouse facilities fund less than 100% of the principal balance of the mortgage loans we own requiring us to use working capital to fund the remaining portion. We may need to use additional working capital if loans become delinquent, because the amount permitted to be financed by the facilities may change based on the delinquency performance of the pledged collateral.

All borrower payments on loans financed under the warehouse agreements are segregated into pledged accounts with the loan servicer. All principal amounts in excess of the interest due are applied to reduce the outstanding borrowings under the warehouse repurchase facilities. The warehouse repurchase facilities also contain customary covenants, including financial covenants that require us to maintain minimum liquidity, a minimum net worth, a maximum debt-to- net worth ratio and a ratio of a minimum earnings before interest, taxes, depreciation and amortization to interest expense. If we fail to meet any of the covenants or otherwise default under the facilities, the lenders have the right to terminate their facility and require immediate repayment, which may require us to sell our loans at less than optimal terms. As of September 30, 2020, we were in compliance with these covenants.

In September, we borrowed $10.6 million against one of our retained bonds with a UPB of $19.3 million under a repurchase agreement with a large investment bank. The loan carries an interest rate of three-month LIBOR plus 4.00% and has a 3 month term that automatically renews for an additional 3 months at the bank’s discretion.

Securitizations

From May 2011 through September 2020, we have completed fifteen securitizations of $3.4 billion of investor real estate loans, issuing $3.1 billion in principal amount of securities to third parties through fifteen respective transactions. All borrower payments are segregated into remittance accounts at the primary servicer and remitted to the trustee of each trust monthly. We are the sole beneficial interest holder of the applicable trusts, which are variable interest entities included in our consolidated financial statements. The transactions are accounted for as secured borrowings under U.S. GAAP. The following table summarizing the investor real estate loans securitized, securities issued, securities retained by us at the time of the securitization, and as of September 30, 2020 and December 31, 2019, and the stated maturity for each securitization. The securities are callable by us when the stated principal balance is less than a certain percentage, ranging from 5%—30%, of the original stated principal balance of loans at issuance. As a result, the actual maturity date of the securities issued will likely be earlier than their respective stated maturity date.

( in thousands)				Equity in Securities Retained as of
Trusts		Securities<br><br><br>Issued		Issuance<br><br><br>Date		September 30,<br><br><br>2020		December 31,<br><br><br>2019		Stated Maturity<br><br><br>Date
2011-1 Trust	74,898	$	61,042	$	13,856	$	—	$	—	August 2040
2014-1 Trust	191,757		161,076		30,682		66		—	September 2044
2015-1 Trust	312,829		285,457		27,372		15,723		15,569	July 2045
2016-1 Trust	358,601		319,809		38,792		17,259		17,931	April 2046
2016-2 Trust	190,255		166,853		23,402		8,907		9,514	October 2046
2017-1 Trust	223,064		211,910		11,154		11,277		11,154	April 2047
2017-2 Trust	258,528		245,601		12,927		15,662		8,293	October 2047
2018-1 Trust	186,124		176,816		9,308		14,431		6,884	April 2048
2018-2 Trust	324,198		307,988		16,210		26,075		12,853	October 2048
2019-1 Trust	247,979		235,580		12,399		22,735		11,767	March 2049
2019-2 Trust	217,921		207,020		10,901		17,759		10,491	July 2049
2019-3 Trust	162,546		154,419		8,127		10,087		7,913	October 2049
2020-1 Trust	261,859		248,700		13,159		20,275		—	February 2050
2020-2 Trust	128,470		96,352		32,118		33,247		—	June 2050
2020-MC1 Trust	275,956		179,371		96,585		98,100		—	July 2050
Total	3,414,985	$	3,057,994	$	356,992	$	311,603	$	112,367

All values are in US Dollars.

The following table summarizes outstanding bond balances for each securitization as of September 30, 2020 and December 31, 2019:

($ in thousands)	September 30, 2020		December 31, 2019
2014-1 Trust	$	25,599	$	31,139
2015-1 Trust		41,190		50,631
2016-1 Trust		62,339		86,901
2016-2 Trust		46,984		63,983
2017-1 Trust		80,174		113,540
2017-2 Trust		138,456		163,295
2018-1 Trust		110,262		134,700
2018-2 Trust		208,206		247,580
2019-1 Trust		192,856		214,709
2019-2 Trust		168,819		200,345
2019-3 Trust		132,893		150,725
2020-1 Trust		233,005		—
2020-2 Trust		94,113		—
2020-MC1 Trust		162,173		—
	$	1,697,069	$	1,457,548

As of September 30, 2020 and December 31, 2019, the weighted average rate on the securities and certificates for the Trusts were as follows:

	September 30, 2020			December 31, 2019
2014-1 Trust		6.97	%		8.33	%
2015-1 Trust		7.52	%		6.37	%
2016-1 Trust		7.54	%		6.75	%
2016-2 Trust		6.40	%		5.59	%
2017-1 Trust		5.08	%		4.56	%
2017-2 Trust		3.34	%		3.50	%
2018-1 Trust		4.02	%		3.95	%
2018-2 Trust		4.51	%		4.44	%
2019-1 Trust		4.05	%		4.00	%
2019-2 Trust		3.42	%		3.44	%
2019-3 Trust		3.25	%		3.27	%
2020-1 Trust		2.84	%		—
2020-2 Trust		4.48	%		—
2020-MC1 Trust		4.50	%		—

Our intent is to use the proceeds from the issuance of new securities primarily to repay our warehouse borrowings and originate new investor real estate loans in accordance with our underwriting guidelines, as well as for general corporate purposes. Our financing sources may include borrowings in the form of additional bank credit facilities (including term loans and revolving credit facilities), repurchase agreements, warehouse repurchase facilities and other sources of private financing. We also plan to continue using securitization as long-term financing for our portfolio, and we do not plan to structure any securitizations as sales or utilize off-balance-sheet vehicles. We believe any financing of assets and/or securitizations we may undertake will be sufficient to fund our working capital requirements.

Preferred Stock and Warrants

On April 7, 2020, we sold 45,000 shares of Preferred Stock and Warrants to purchase 3,013,125 shares of our common stock in a private placement to two of our largest stockholders. These offerings resulted in net proceeds of $43.2 million.

Beginning on October 5, 2022, but in no event later than November 28, 2024, each holder of Preferred Stock has the option to cause us to repurchase all or a portion of such holder’s shares of Preferred Stock, for an amount in cash equal to the liquidation preference of each share repurchased. The Preferred Stock has a liquidation preference equal to the greater of (i) $2,000 per share from April 7, 2020 through October 5, 2022, which amount increases ratably to $3,000 per share between October 6, 2022 and November 28, 2024 and to $3,000 per share from and after November 28, 2024 and (ii) the amount such Preferred Stock holder would have received if the Preferred Stock had converted into common stock immediately prior to such liquidation. We also have an obligation to repurchase the Preferred Stock for cash at a price per share equal to the liquidation preference in the event of a change of control (as defined in the certificate of designation governing the Preferred Stock).

The Warrants are exercisable at the warrantholder’s option at any time and from time to time, in whole or in part, until April 7, 2025 at an exercise price of $2.96 per share of common stock with respect to 2,008,750 of the Warrants, and at an exercise price of $4.94 per share of common stock with respect to 1,004,374 of the Warrants.

Contractual Obligations and Commitments

The following table illustrates our contractual obligations existing as of September 30, 2020:

	Remainder of		January 1, 2021 -		January 1, 2023 -
($ in thousands)	2020		December 31, 2022		December 31, 2022		Thereafter		Total
Warehouse and repurchase facilities	$	17,123	$	2,700	$	—	$	—	$	19,823	(1)
Notes payable (corporate debt)		195		1,560		76,245		—		78,000	(2)
Leases payments under<br><br><br>noncancelable operating leases		393		3,185		2,460		55		6,093
Total	$	17,711	$	7,445	$	78,705	$	55	$	103,916
(1)	Amount represents gross warehouse and repurchase borrowing. Balance of $19.5 million in the consolidated balance sheets as of September 30, 2020 is net of $0.3 million debt issuance costs.
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(2)	Amount represents gross corporate debt. Balance of $74.8 million in the consolidated balance sheets as of September 30, 2020 is net of $3.2 million debt issuance costs.
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Off-Balance-Sheet Arrangements

At no time have we maintained any relationships with unconsolidated entities or financial partnerships, such as entities referred to as structured finance, or special-purpose or variable interest entities, established for the purpose of facilitating off-balance-sheet arrangements or other contractually narrow or limited purposes. Further, we have never guaranteed any obligations of unconsolidated entities or entered into any commitment or intent to provide funding to any such entities.

Forward-Looking Statements

This Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to the “safe harbor” created by those sections. All statements (other than statements of historical facts) in this Quarterly Report regarding the prospects of the industry and our prospects, plans, financial position and business strategy may constitute forward-looking statements. In addition, forward-looking statements generally can be identified by the use of forward-looking terminology such as “may,” “should,” “expect,” “intend,” “will,” “estimate,” “anticipate,” “plan,” “believe,” “predict,” “potential” or “continue” or the negatives of these terms or variations of them or similar terminology. Forward-looking statements may contain expectations regarding our operations, including the resumption of loan originations, our ability to resolve non-performing loans and avoid losses on non-performing loans and the disposition of REOs and other results, and may include statements of future performance, plans and objectives. Forward looking statements also include statements pertaining to our strategies for future funding and development of our business and products. Although we believe that the expectations reflected in these forward-looking statements have a reasonable basis, we cannot provide any assurance that these expectations will prove to be correct. Such statements reflect the current views of our management with respect to our operations, results of operations and future financial performance. It is possible that the actual results may differ, possibly materially, from the anticipated results indicated in these forward-looking statements. Information regarding important factors that could cause actual results to differ, perhaps materially, from those in our forward-looking statements is contained in this Quarterly Report and other documents we file. You should read and interpret any forward-looking statement together with these documents, including the following:

•	the description of our business and risk factors contained in our Annual Report on Form 10-K for the year ended December 31, 2019 and filed with the Securities and Exchange Commission (“SEC”) on April 7, 2020
•	the risk factors contained in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2020 and filed with the SEC on May 14, 2020
---	---
•	the discussion of our analysis of financial condition and results of operations contained in this Quarterly Report under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations”
---	---
•	the notes to the consolidated financial statements contained in this Quarterly Report
---	---
•	cautionary statements we make in our public documents, reports and announcements
---	---

Any forward-looking statement speaks only as of the date on which that statement is made. We will not update any forward-looking statement to reflect events or circumstances that occur after the date on which the statement is made, except as required by applicable law.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Not applicable.

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures.

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rules 13a-15(e) and 15d-15(e) under the Exchange Act as of the end of the period covered by this report. Our disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and that such information is accumulated and communicated to the our management, including the our Chief Executive Officer and Chief Financial Officer to allow timely decisions regarding required disclosure. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objective, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2019, in reviewing the accounting for a certain transaction we completed in January 2018, as part of our 2018 election to be treated as a corporation for U.S. federal and state income tax purposes, our management identified a deficiency in the effectiveness of a control intended to properly document and review relevant facts and apply the appropriate tax accounting under U.S. GAAP, which impacted the beginning of year deferred tax asset and income tax benefit accounts and related disclosures. Management concluded that it had not implemented an effective control structure to prevent or detect the material misstatement in calculating the beginning of year deferred tax position. In 2019, we implemented a plan to remediate this material weakness by contracting with a nationally recognized accounting firm to have experienced tax personnel supplement and train our current accounting team. As a result, additional internal controls over our income tax processes have been designed and implemented.  In 2020, management will assess whether these internal controls over income taxes are performing as designed. Management has concluded that the material weakness remains as of September 30, 2020, pending further testing of the internal controls.

In accordance with Rule 13a-15(b) of the Exchange Act, our management, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this quarterly report and has concluded that, notwithstanding the identified material weakness in our internal controls, our disclosure controls and procedures, as of such date, were effective to accomplish their objectives at a reasonable assurance level. Management concluded that, notwithstanding the material weakness in our internal controls, the consolidated financial statements for the periods covered by and included in this Quarterly Report on Form 10-Q fairly present, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with U.S. GAAP.

Changes in Internal Control over Financial Reporting.

During the period to which this report relates, there have not been any changes in the Company's internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that have materially affected, or that are reasonably likely to materially affect, such controls.

Item 1. Legal Proceedings.

From time to time, in the ordinary course of business, we are involved in various judicial, regulatory or administrative claims, proceedings and investigations. These proceedings and actions may include, among other things, allegations of violation of banking and other applicable regulations, competition law, labor laws and consumer protection laws, as well as claims or litigation relating to intellectual property, securities, breach of contract and tort. We intend to defend ourselves vigorously against any pending or future judicial, regulatory or administrative claims or proceedings. Although occasional adverse decisions or settlements may occur, our management does not believe that the final disposition of any currently pending or threatened matter will have a material adverse effect on our business, financial position, results of operations or cash flows.

On July 9, 2020, a class action complaint was filed in the United States District Court for the Central District of California, naming us, certain of our directors, officers and shareholders and others alleging violations of securities laws, including making false and misleading statements and omissions in our offering materials for our January 2020 initial public offering of our common stock.  The complaints seek unspecified damages and an award of costs and expenses, including attorneys’ fees.  We intend to vigorously defend against this action.

Item 1A. Risk Factors.

Intentionally omitted pursuant to smaller reporting company reduced disclosure requirements.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

Not applicable.

Item 3. Defaults Upon Senior Securities.

Not applicable.

Item 4. Mine Safety Disclosures.

Not applicable.

Item 5. Other Information.

None.

Item 6. Exhibits.

The exhibits below are filed as part of, or incorporated by reference into, this Quarterly Report on Form 10-Q.

		Incorporated by Reference
Exhibit<br><br><br>Number	Exhibit Title	Form	File No.	Exhibit	Filing Date
3.1	Certificate of Conversion	8-K	001-39183	3.1	1/22/2020
3.2	Certificate of Incorporation of Velocity Financial, Inc.	8-K	001-39183	3.2	1/22/2020
3.3	Bylaws of Velocity Financial, Inc.	8-K	001-39183	3.3	1/22/2020
3.4	Certificate of Designation of Series A Convertible Preferred Stock of Velocity Financial, Inc.	8-K	001-39183	3.1	4/7/2020
4.1	Form of Warrant to Purchase Common Stock	8-K	001-39183	4.1	4/7/2020
10.1	Stockholders Agreement, dated as of January 16, 2020	10-K	001-39183	10.1	4/7/2020
10.2	Registration Rights Agreement, dated as of January 16, 2020	10-K	001-39183	10.2	4/7/2020
10.3	Velocity Financial, Inc. 2020 Omnibus Incentive Plan*	8-K	001-39183	10.1	1/22/2020
10.4	Form of Nonqualified Stock Option Award Notice and Agreement under the 2020 Omnibus Incentive Plan*	S-1/A	333-234250	10.6	1/6/2020
10.5	Form of Nonqualified Stock Option Award Notice and Agreement (Director Grant-IPO) under the 2020 Omnibus Incentive Plan*	S-1/A	333-234250	10.7	1/6/2020
10.6	Form of Nonqualified Stock Option Award Notice and Agreement (Executive Officer Grant-IPO) under the 2020 Omnibus Incentive Plan*	S-1/A	333-234250	10.8	1/6/2020
10.7	Form of Restricted Stock Unit Grant and Agreement (Director Grant) under the 2020 Omnibus Incentive Plan*	S-1/A	333-234250	10.9	1/6/2020
10.8	Form of Restricted Stock Unit Grant and Agreement (Standard Grant) under the 2020 Omnibus Incentive Plan*	S-1/A	333-234250	10.10	1/6/2020
10.9	Form of Restricted Stock Grant and Agreement under the 2020 Omnibus Incentive Plan*	S-1/A	333-234250	10.11	1/6/2020
10.10	Amendment No. 2 to the Credit Agreement among Velocity Financial, LLC, Velocity Commercial Capital, LLC and Owl Rock Capital Corporation, dated as of February 5, 2020	10-K	001-39183	10.39(b)	4/7/2020
10.11	Form of Officer and Director Indemnity Agreement*	S-1/A	333-234250	10.37	11/6/2019
10.12	Registration Rights Agreement, dated as of April 7, 2020	8-K	001-39183	10.1	4/7/2020
31.1	Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Principal Financial and Accounting Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of Principal Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002+
32.2	Certification of Principal Financial and Accounting Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002+
101.INS	XBRL Instance Document
101.SCH	XBRL Taxonomy Extension Schema Document
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document
101.LAB	XBRL Taxonomy Extension Label Linkbase Document
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document
*	Management contract or compensatory plan or arrangement.
---	---
+	This certification is deemed not filed for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference into any filing under the Securities Act or the Exchange Act
---	---

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	VELOCITY FINANCIAL, INC.
Date:  November 12, 2020	By:	/s/ Christopher D. Farrar
		Christopher D. Farrar
		Chief Executive Officer
Date:  November 12, 2020	By:	/s/ Mark R. Szczepaniak
		Mark R. Szczepaniak
		Chief Financial Officer

54

vel-ex311_9.htm

Exhibit 31.1

CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER

PURSUANT TO SECTION 302 OF

THE SARBANES-OXLEY ACT OF 2002

I, Christopher D. Farrar, certify that:

1.	I have reviewed this Quarterly Report on Form 10-Q of Velocity Financial, Inc.;
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
---	---
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
---	---
4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
---	---
a.	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
---	---
b.	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
---	---
c.	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
---	---
5.	The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
---	---
a.	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
---	---
b.	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
---	---
Date:	November 12, 2020	By:	/s/ Christopher D. Farrar
---	---	---	---
			Christopher D. Farrar
			Chief Executive Officer
			(Principal Executive Officer)

vel-ex312_6.htm

Exhibit 31.2

CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER

PURSUANT TO SECTION 302 OF

THE SARBANES-OXLEY ACT OF 2002

I, Mark R. Szczepaniak, certify that:

1.	I have reviewed this Quarterly Report on Form 10-Q of Velocity Financial, Inc.;
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
---	---
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
---	---
4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
---	---
a.	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
---	---
b.	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
---	---
c.	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
---	---
5.	The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
---	---
a.	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
---	---
b.	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
---	---
Date:	November 12, 2020	By:	/s/ Mark R. Szczepaniak
---	---	---	---
			Mark R. Szczepaniak
			Chief Financial Officer
			(Principal Financial Officer)

vel-ex321_7.htm

Exhibit 32.1

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Velocity Financial, Inc. (the “Company”) on Form 10-Q for the period ended September 30, 2020 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Christopher D. Farrar, certify pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:

(1)	The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and
(2)	The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
---	---
Date:	November 12, 2020	By:	/s/ Christopher D. Farrar
---	---	---	---
			Christopher D. Farrar
			Chief Executive Officer
			(Principal Executive Officer)

vel-ex322_8.htm

Exhibit 32.2

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Velocity Financial, Inc. (the “Company”) on Form 10-Q for the period ended September 30, 2020 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Mark R. Szczepaniak, certify pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:

(1)	The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and
(2)	The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
---	---
Date:	November 12, 2020	By:	/s/ Mark R. Szczepaniak
---	---	---	---
			Mark R. Szczepaniak
			Chief Financial Officer
			(Principal Financial Officer)