Earnings Call Transcript - VEL Q1 2021

Operator, Operator

Good day and welcome to the Velocity Financial First Quarter 2021 Earnings Conference Call. All participants will be in a listen-only mode. Please note, this event is being recorded. I would now like to turn the conference over to Chris Oltmann. Please go ahead.

Chris Oltmann, Director of Investor Relations

Thank you, Bessie. Hello everyone and thanks for participating in Velocity Financial's first quarter 2021 earnings call. Joining me today are Chris Farrar, Velocity's President and Chief Executive Officer, and Mark Szczepaniak, Velocity's Chief Financial Officer. Earlier this afternoon, we released our first quarter 2021 press release and the accompanying earnings presentation, which are available on our Investor Relations website. I'd like to remind everybody that today's call may include forward-looking statements, which are uncertain and outside of the company's control and actual results may differ materially. For a discussion of some of the risks and other factors that could affect results, please see the risk factors and other cautionary statements made in our communications with shareholders, including the risk factors disclosed in our filings with the Securities and Exchange Commission. Also note that the content of this conference call contains time-sensitive information that is accurate only as of today, and we do not undertake any duty to update forward-looking statements. We may also refer to certain non-GAAP measures on this call. For reconciliations of these non-GAAP measures, you should refer to the earnings materials on our Investor Relations website. Finally, today's call is being recorded and will be available on the company's website later today. I will now turn the call over to Chris Farrar for opening remarks. Chris?

Chris Farrar, CEO

Great, thank you Chris and welcome everyone to the 2021 Q1 call. Our team is very pleased with the results we presented today, as our business continues to perform very well. Originations were up from the prior quarter, and our pipeline for the second quarter continues to grow. This is especially impressive for two reasons. First, we produced almost the same volume in Q1 versus last year without offering any short-term loans, which were about 30% of last year’s Q1 volume. Second, we accomplished this with fewer team members which obviously indicates significant operating efficiency. Clearly, things are going well on the origination front. In terms of our portfolio, our special servicing team had another very strong quarter of recoveries, as we continue to resolve delinquent loans profitably. I think it’s important to highlight that our portfolio yield is within a few basis points of the actual coupon, demonstrating that our recoveries are almost completely offsetting the interest shortfall from non-accrual loans. While real estate markets are very strong nationwide, and continue to help us, our hands-on special servicing team is doing a great job. Looking forward, there are two important areas we plan to detail in the future course. From a financial reporting perspective, most other lenders use fair value accounting, and we choose to use an amortized cost method which reduces quarterly volatility. As a result, we have significant embedded gains in the business that are not readily apparent. We plan to develop an economic book value in future quarters to easily identify the inherent unreported value we've created, which is significant and hopefully helpful to investors when comparing our company to others. On the ESG front, we are compiling a study that demonstrates the impact our lending has on underserved populations nationwide. We think this is an important attribute of our unique niche as we’re fulfilling our mission to finance communities where people live, work, and play. Early results show that we have an impressive footprint in diverse neighborhoods across the U.S. In summary, we’re fortunate to have strong demand, healthy capital markets, and engaged team members to maximize our opportunities. As always, we appreciate your continued support and we’re energized to continue growing our company. That concludes my prepared remarks, and we’ll turn over to the PowerPoint presentation with the earnings highlights. On Page 3, at a high level just going through kind of some of the items in the quarter, net income on a core basis was $0.20 a share. The real adjustment there is the cost associated with refinancing our long-term debt. Net interest margin is very solid at 4.1% and continues to impress as I mentioned with all of the recoveries that were made on non-performing loans. And then from a book value perspective, obviously nice trajectory there as well. From a production perspective, $233 million originated in the first quarter at a 30% quarter-over-quarter increase. Everyone on that operations and sales team did a great job and we’re seeing tremendous demand there. In terms of NPLs, total recoveries of 1027, again showing gains over and above our normal contractual interest and we’ll have some more details on that later on. NPLs are starting to trend down slightly; it takes time and it’s kind of a slow-moving ship, but we’re seeing progress there, and we’re very pleased to see that charge-offs continue to remain extremely low. From a financing and capital perspective, we've already previously announced a $175 million debt facility, which we drew down fully during the quarter to continue to fund growth. Lastly, we added another non-mark-to-market warehouse facility with a very large bank in the quarter for another $100 million. So we've got plenty of capacity and all done on a non-mark-to-market basis. So all those things put together make us very optimistic about the quarters ahead. With that, I will turn it over to Mark to take us through the details.

Mark Szczepaniak, CFO

Thank you, Chris, and hello everyone. On Page 4, we examine the reconciliation between our GAAP income for the quarter and our book income. Our GAAP income was $3.4 million, while on a core basis, it amounted to $6.7 million. Chris noted the $3.3 million difference, which is related to our debt refinancing. We refinanced our corporate debt in the first quarter and paid off our existing corporate debt. This led to deferred deal costs, write-offs, and prepayment fees, resulting in approximately $4.5 million of pre-tax write-offs. Therefore, the core income stands at $6.7 million. To the right, you can see the book value of equity per share decreased from $12.31 to $3.31. As Chris pointed out, the $11.12 includes a $0.17 write-off related to the debt refinancing. Without this refinancing, based purely on operations, adding back the $0.17 to the $11.12 gives us $11.29. As Chris mentioned, we are looking to provide a more accurate economic value of equity per share alongside the book value to better illustrate the inherent gains in our business. On Slide 5, regarding production, we noted a significant increase from Q4 to Q1, with a 30% jump from $179 million in UPB in Q4 to $233 million. This figure is comparable to the first quarter of 2020 before COVID. Remember that the $248 million figure from Q1 2021 included our short-term loan product, while the $233 million reflects our long-term 30-year product without any short-term product. This quarter is strong without short-term offerings. In April, we informed brokers that we are now offering our ARV Pro short-term product again, along with a new short-term product called the Flex interest-only product. On Page 6, our loan portfolio finished the quarter just below $2 billion at $1.99 billion, which included selling $57 million worth of UPB during Q1. Without that sale, the portfolio would have exceeded $2 billion. It's also worth noting that comparing this first quarter with the first quarter of 2021, our one to four rental property portfolio has grown significantly from about 40% of our total portfolio to around 49%. The loan portfolio growth from $1.94 billion at the end of last year to $1.99 billion at the end of March is evident in the slide. On Page 7, Chris mentioned that our non-performing loan resolutions have been strong and consistent. In total, we resolved $49 million worth of UPB in the quarter, resulting in a total gain of $1.3 million over its contractual principal interest, which equates to about a 2.7% gain for the quarter. Starting in Q1, we separated our NPL resolutions into two distinct tables. The top table represents our normal long-term 30-year product, which constitutes the majority of our portfolio and excludes loans that received COVID forbearance during 2020. The bottom table includes short-term loans and long-term loans that did receive COVID forbearance. We decided to split these for better transparency and to provide investors more detailed information on the different products we resolve. For our long-term 30-year loans, when they resolve with a full payoff, we receive default interest and prepayment fees that contribute to the gain. Comparing the long-term loans, we saw $29 million in resolutions in Q1 compared to $30 million in Q4, with gains of 3.2 compared to 3.5. Regarding short-term loan resolutions, we did not report those separately in 2020 because they were held for sale for most of the year. We only transitioned them to held investments towards the end of Q3, and our special sourcing team is now tracking these resolutions. Once we moved those loans to held investments, we are now monitoring them closely as we reintroduce the short-term product starting this quarter. Short-term loans do not incur prepayment fees, and their gains are expected to be lower due to this absence. The bottom table details the longer-term loans that received COVID forbearances, which are new for the first quarter. Most of these loans were modified or brought current by the time they entered forbearance, leading to non-performance issues closer to year-end. On Page 8, Chris mentioned that our net interest margin at the end of the quarter was 410 basis points compared to 407 in Q4, and 418 basis points as far back as Q1 of 2020. This consistency is positive, especially considering the challenges of 2020 when loan production was suspended for over six months. We’ve maintained a margin above 400 basis points throughout that period. The yield remained strong at 841 at the end of the quarter, and our strong resolutions, default interest, and prepayment fees largely offset the impact from non-performing loans. The cost of funds saw a slight increase of 4 basis points from the end of the year to Q1 due to new warehouse lines initiated in the quarter. On Page 9, we discussed the performance of our loan investment portfolio. Non-accruals have remained moderate and consistent, actually decreasing slightly from 17.2% to 16.8%. Although it will take time to address the non-performing loans, we continue to maintain close to a 4.3% gain on resolutions. Slide 10 shows our CECL reserve was around $5.9 million at the end of Q1, aligning with the year-end figure, which indicates stability. We have conducted various models under COVID stress scenarios, similar to last year. While some companies have reduced their reserves, we are growing our portfolio and adding more loans. As the impact of vaccinations unfolds, we exercise cautious optimism and will maintain our reserve steady until we have more data in the upcoming quarters. As noted at the bottom right of that slide, our charge-offs remain very low. In Q4, it was just 37 basis points on an annualized basis, and for Q1, it stands at 8 basis points. The low charge-offs can be attributed to our strong resolutions, with 94% of resolutions resulting in loans that paid off or became current, yielding an overall gain of 2.7%. Chris, I’ll hand it back to you.

Chris Farrar, CEO

Great. Thank you, Mark. I'll just wrap up here on Slide 11 and then we can take some questions. I think from a high-level view of the economy, we are starting to see things improve and loosen up. We're definitely seeing that government stimulus and programs are starting to help some of our borrowers and their tenants indirectly. We hope that will continue to help us resolve those delinquent loans as well as make new loans to new borrowers. I think, I mentioned, but I think everybody knows the real estate market is extremely strong right now, so that's obviously helping us as well. From just a capital and liquidity perspective, we've got plenty of financing in place to handle our growth. We're out in the market right now with our first securitization of the year, so I can't really say anything about that, but we'll update everyone as soon as we can on that. I think we're very well positioned to take advantage of all the different growth we see moving forward. So that wraps up our prepared presentation, and we'll turn it back for questions.

Operator, Operator

We will now begin the question and answer session. At this time, we will pause momentarily to assemble our roster. Our first question comes from Don Fandetti with Wells Fargo. Please go ahead.

Don Fandetti, Analyst

Hi, I was wondering if you can elaborate a little bit on where your embedded gains would be coming from, given that it's a loan portfolio.

Chris Farrar, CEO

Yes, sure Don. If you just look at the economic or fair value of the loans that we have on the sheet, it would be much higher. Indirectly, if you wanted to take a quick look at it, you could just look at our fair value disclosure footnote, and that would probably be the best way to see it on the asset side. However, we're going to fine-tune that a little more and make a full presentation. Obviously, if we were to use fair value accounting, that increase on the loan side would come through to equity as well as through the earnings statement, resulting in an increase in book value, so that's where it's coming from.

Don Fandetti, Analyst

Got it. And is there anything to the MTL improvement? Should we just expect to see that slow improvement throughout the year?

Chris Farrar, CEO

Yes, I think that's our expectation. In the mid-term, it's slow and steady. It's going to take a while, and we don't expect it to just quickly recover. We think a lot of these resolutions are going to take time to work through the process and resolve themselves.

Don Fandetti, Analyst

Got it. Thank you.

Chris Farrar, CEO

Yes.

Operator, Operator

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

Arren Cyganovich, Analyst

Thank you. The production volume number was impressive for the quarter, particularly in the investor one-four side. Is that just indicative of a change in demand or have there been some changes to your marketing to achieve that higher level of volume?

Chris Farrar, CEO

Yes, hi Arren. Good to hear from you. I think it's a function of both. We think it's increased demand, but also no change to our programs. Operationally, we are kind of hitting our stride and getting back in the groove, and there’s a little bit of seasonality in there with January and December, year-end stuff that can always bounce around a little bit. So, I think all three of those combined add to the growth. We definitely see our account executives are being more productive, and that’s not from changing our guidelines or new programs, that's just their inherent productivity.

Arren Cyganovich, Analyst

Okay. And then, offering your short-term loan product again starting in April, are you changing the underwriting standards at all, or will it be kind of similar expected volumes as what you used to post?

Chris Farrar, CEO

Yes, it's hard to say. We're not sure yet what kind of traction we're going to get there. I can tell you early on in the month of April we did see a lot of demand there, saw a lot of applications. So, I am pretty optimistic that it’s going to come back to somewhere around that level. We did brace our credit minimums and tightened the box a little, so it might not be quite as robust as it was before. But, it should be significant after we get a couple of quarters under our belt.

Arren Cyganovich, Analyst

Okay. And then, just lastly, following up on Don’s question, when we look at the breakdown on Slide 9 of the delinquency status of the loans, those non-accruals there, it looks like a big chunk of them are in foreclosure. What’s a typical timeline? I know it probably varies by state depending on if it’s judicial or non-judicial. I know that sometimes some of the judicial states can take years, and I am just trying to think about how long some of this might hang out.

Chris Farrar, CEO

Yes. So, what you see is the delinquency kind of quickly rolls 30, 60, and 90 days, and then into foreclosure. To your point, it sits in foreclosure quite a while, because it depends on how fast we can get through the various state processes. On average, we are running about 10 to 11 months in foreclosure status before we see a resolution. This doesn’t mean that it’s a 'foreclosure sale'; it just means that the loan either comes current or gets paid off. In some of the longer states, you have borrowers who wait until the very last minute before they reinstate or pay us off, while in a short state like Texas, you can foreclose in 60 days. To your point, it varies across the U.S., but on average, it’s about 10 months or so that we experience.

Arren Cyganovich, Analyst

Okay. Thank you.

Chris Farrar, CEO

Yes.

Operator, Operator

The next question comes from Chris Muller with JMP Securities. Please go ahead.

Chris Muller, Analyst

Hey guys. Thanks for taking my question. I’m on for Steve today. I have a couple of things, but I guess just a follow-up on origination volumes. Once we do reach that normalized market, do you think that our volumes will be closer to that 30% in each bucket breakout, or do you feel like the SFR is going to have a stronger rating going forward?

Chris Farrar, CEO

Yes. On the short-term product, that’s all one to four, so it will skew more heavily to the one to four because we don’t offer that short-term product for commercial assets yet. We’ll offer that sometime in the future, but right now it’s all one to four.

Chris Muller, Analyst

Got it. And then, on the other side of the equation, do you guys have any expectations for repayment of loans for this year?

Chris Farrar, CEO

We don’t. We don’t try to forecast that; it’s too tricky to do. We are accruing default interest while it happens, so whether it happens this week, next week, or next month, we are somewhat indifferent because it’s very profitable for us, and it’s lumpy. It’s hard to predict, so we don’t try to forecast that.

Chris Muller, Analyst

Alright. Thanks for that.

Mark Szczepaniak, CFO

Sorry, I would like to add in there. When Chris said we accrue for default interest, it’s really clear. We record the default interest on a cash basis; we don’t reserve or approve for it, we just book it when we receive it.

Chris Farrar, CEO

Right, and thanks Mark for clarifying. It's accruing to the borrower at all times is what I meant to say; I didn’t mean in our financial statements, but it’s something that’s owed to us.

Chris Muller, Analyst

Right. Thanks for taking the questions.

Chris Farrar, CEO

Okay.

Operator, Operator

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

Chris Farrar, CEO

Thank you all for participating. We appreciate it and look forward to our next update after Q2. Thank you.

Mark Szczepaniak, CFO

Thank you everybody.

Operator, Operator

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