Velocity Financial (NYSE:VEL) Q1 2021 Earnings Call

0:00 Welcome to the Velocity Financial first quarter 2021 earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing star, then zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on a touch-tone phone. To withdraw your question, please press star, then two. Please note, this event is being recorded. I would now like to turn the conference over to Chris Oltmann. Please go ahead.

0:34 Thank you, Betsy. 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 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.

1:26 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.

1:58 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.

2:51 I think it's important to highlight Thank you for joining us. 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.

3:49 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 US. 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.

4:36 On page three, at a high level, just going through kind of some of the items in the quarter, net income on a core basis 20 cents 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, a 30% Q over Q increase.

5:25 Everyone on the 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 starting to trend down slightly. It takes time, and it's kind of a slow-moving ship, but we're seeing progress there. And 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.

6:14 And then lastly, I'd just add here that we added another non-market warehouse facility with a very large bank in the quarter for another $100 million debt. We've got plenty of capacity and all done on a non-mark-to-market basis. 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.

6:43 Thanks, Chris. Hi, everybody. On page four, we take a look at the reconciliation between our gap income for the quarter and book income. Our gap income was about $3.4 million. But on a core basis, the core income was $6.7 million. And Chris alluded to the $3.3 million delta there was related to the debt refinancing. And we did refinance our corporate debt in Q1. And we paid off the existing, the older corporate debt. We paid off the existing corporate debt. We had some deferred deal costs write-offs and some prepayment fees as a result of paying off that debt. And that resulted in about $4.5 million of write-offs pre-taxed. or that 3.3 that you're seeing and a net effect of adjusting the GAAP income to the core income. So on a core basis, 6.7 million.

7:31 To the right there, you just see the roll forward of the book value of equity per share from 1231 to 331, as Chris mentioned, 1093 to 1112. Kind of a key point there is you see the 1112 includes that 17 cents write-off. That's the The one-time write-up that we talked about in refinancing the debt. So really, without having that debt refinanced during the quarter, just based on operations, you could add the 17 cents back to the 11.12, and you're really almost at 11.29, just based on operational basis. And as Chris mentioned, we are working on coming up with a more economic value of equity per share to kind of go along with the book to show the inherent gains and value embedded in the business. On slide five, production. Production has increased significantly from Q4 to Q1, about a 30% increase, going from $179 million in UPB and Q4 to $233 million.

8:27 As Chris had mentioned, the 233 is very comparable to the first quarter of 2020 pre-COVID. And at 248, remember the 248 had our short-term loan product in there, Q1 of 21, the $233 million is all of just our 30-year long-term product. There's no short-term product in there, so it's a very strong quarter there. are not offering a short-term product. Now, in April, we did go out and announce to all the brokers that we are now offering our ARV Pro short-term product that we had offered pre-COVID, as well as a new short-term product called our Flex Interest Only product. So we are now taking applications and back offering our short-term product. On page six, the loan portfolio. Loan portfolio ended the quarter just shy of $2 billion, $1.99 billion.

9:15 and the $1.99 billion that included selling $57 million worth of UPB during Q1. So, you know, absent that sale, the portfolio would have been over $2 billion. But $1.99 billion ending the quarter. And the other positive to note there is comparing the first quarter of 2020 to first quarter of 21 year over year, our one to four rental property portfolio has really grown. We've gone from about 40% of our total portfolio being the one to four Family Property, to now at the end of Q1-21, we're close to 49%. So we've seen strong demand, investor demand, on these one-to-four residential properties. And you can see the loan portfolio waterfall in the bottom right of that slide just showing the growth from the $1.94 billion at the end of the year to the $1.99 billion at the end of 331, and you can see that $57 million UPB loan sale in that roll forward.

10:13 Page 7, Chris mentioned NPL, non-performing loan resolutions, have remained strong and consistent. In total, we resolved $49 million worth of UPB in the quarter for a total $1.3 million gain over and above the contractual principal interest or about 2.7% gain for the quarter. What we've done now, starting with Q1 of this year, is we've taken those NPL resolutions and we've broken them out into two separate tables. So the top table represents our normal long-term 30-year products, and that's the bulk of our portfolio. And it's the 30-year product for loans that did not receive a COVID forbearance during 2020. And we'll get into that in just a minute. The bottom table is our short-term loans, as well as any of the long-term loans that did receive a COVID forbearance.

11:06 The reason we felt that starting this year, it's appropriate to split it out is we wanted to provide more transparency and more information. to the investors based on the different types of products and the characteristics when we resolve the loans. Our long-term 30-year loans, when those loans pay off, when the resolution is a full payoff, we receive default interest and prepayment fees. So that makes up the gain. And you can see in the top table, by just comparing the long-term loans, it's $29 million in resolution compared to the fourth quarter of 30 and a 3.2 gain compared to 3.5. So that's kind of an apples-to-apples comparison. and what we're seeing now in Q1 from a couple things. One, we now have the short-term loan resolutions. We didn't show those separately in 2020 because for most of 2020, the short-term loans were held for sale. They weren't part of our held for investment portfolio.

11:56 It wasn't until towards the end of Q3 that we moved them over to held for investment and now our special servicing team is tracking them and they're getting involved in the resolutions. Prior to that, when we were selling the loans, once we sell them, we're not in charge of them. We don't do any of the resolutions. So now that we have those loans as health and investment, and it's our intent going forward with opening up the short-term product going forward, that we're going to put them in health for investment. Starting this quarter, first quarter of this year, we're tracking those loans. And the short-term loans, the reason we're bringing them out separate, they do not have prepayment fees. So they have default interest if they pay off or pay current and they're not performing, but they don't have prepayment fees. So their gains would be expected to be a little bit less because there's no prepayment fees associated with short-term products. and then also in that bottom table are the longer-term loans, the 30-year product that did receive COVID forbearances.

12:47 That's kind of something new for the first quarter because the loans that did get forbearances during 2020, by the time they received the forbearance and the majority of those loans were modified or brought current, by the time all that happened, it was going into say Q3. Then if the borrowers went non-performing coming out of that forbearance, so another 90 days and they went non-performing, That brought it right to year end. So we're first starting to see the resolutions coming through on those loans in Q1. And again, because they're loans that went into COVID forbearance, more often than not, if the borrower wants to pay off the loan, we probably would waive the prepayment fee. It's a case-by-case basis, but because we gave them a COVID forbearance, we're more likely to waive it. So we felt that's a different characteristic than the long-term loans without prepayment fees. So that's why the tables are split.

13:34 We're hoping that it gives investors, analysts more information and detail about the different characteristics of our products as we monitor these non-performing loan resolutions. On page eight, Chris kind of mentioned our net interest margin, end of the quarter at 410 basis points compared to 407 for Q4. There's like 418 basis points all the way back to Q1 of 2020. Again, the very positive there is even during a tumultuous 2020 with COVID and a suspension of loan production for over six months, we've maintained a very constant margin of over north of 400 basis points. And we've talked before about our locked-in spread and our in-place portfolio generating a locked-in spread.

14:21 And I think that was very, very strongly demonstrated during a pretty rough year last year. And we've maintained that 400-bip score higher throughout the entire year. The right-hand side shows our portfolio yield and the cost of funds that kind of comprise the 400 basis points of net margin. The yield has remained strong at 841 at the end of the quarter. As Chris mentioned, our yield is pretty much on top of our WAC, which is a positive. Obviously, the WAC, we have non-performing loans that take away from the WAC. As Chris mentioned, our strong resolutions, default interest and prepayment fees is pretty much offsetting The loss of interest income from the non-performing loans to keep that whack in check. And on the cost of funds, again, very consistent.

15:06 You know, just four basis points change from end of the year to Q1. And the slight uptick for Q1 is, as Chris mentioned, some of these new warehouse lines that we put in place in Q1. We were just first ramping those up in the quarter, and they do have fixed fees. So you have the same fee for the quarter, but you don't have the full balance of the loan on there for the quarter. So that just kind of results in a little bit of a tick up in the cost of funds. as we now get more and more loans on those warehouse lines and fully utilize the lines, those costs would be absorbed into the higher average balance. Slide nine, the loan investment portfolio performance. We've talked about non-accruals have stayed pretty moderate, consistent from Q4 to Q1. They actually went down slightly, about 40 basis points in terms of non-performing rates, 17.2 to 16.8.

15:57 As Chris mentioned, it will take some time to start working off all those non-performing loans, but the key takeaway is, as we are working off the non-performings, we're maintaining that close to 3.3% gain on all the resolutions, so still strong resolutions as we're resolving those. And slide 10 is our CECL Reserve. CECL Reserve at the end of Q1 was right around $5.9 million, which is where we ended the year. The loan loss reserve is flat. We ran multiple different models under COVID stress scenario, just like we did at the end of the year. I know we've heard about some companies saying they're backing off some of the reserves, reversing some of the reserves. We just thought we're growing our portfolio again.

16:42 We're adding a lot more loans on the line. We've got more warehouse lines in place to be able to fund the higher originations coming in. and yes, COVID vaccines are out there. People are getting them. It's just a little soon to tell what the impact's going to be long-term. So I guess I say it's with cautious optimism that we're watching the economy and the market as everything starts to reopen and we're just kind of holding that reserve steady for now until we get another quarter or two under the belt and see where things go. And at the bottom right of that slide, as Chris mentioned, our charge-offs remain very, very low. I mean, even for Q4, it was only 37 basis points on an annualized basis. But based on the charge-offs at Q1, it's eight basis points on an annualized basis. So our charge-offs remain low. And part of the reason for that is, we just said, those resolutions remain high. In Q1, you know, 94% of all the resolutions in Q1, the non-form loan resolutions in Q1, were loans that paid off or paid current and an overall 2.7% gain. So that's one of the reasons that the charge-offs are also so low, the strong resolutions.

17:47 Chris, with that, I'll turn it back to you.

17:50 Great. Thank you, Mark. I'll just wrap up here on 11, and then we can take some questions. I think from a high-level view of the economy, we're starting to see things improve and loosen up. I definitely see that government stimulus and programs is starting to help some of our borrowers and their tenants indirectly, so we hope that 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.

18:35 And then 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. And I think we're very well positioned to take advantage of all the different growth we see going forward. So that wraps up our prepared presentation, and we'll turn it back for questions. We will now begin the question and answer session. To ask a question, you may press star then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys.

19:23 If at any time your question has been addressed and you would like to withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster. Our first question comes from Don Fandetti with Wells Fargo. Please go ahead.

19:43 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.

19:55 Yeah, sure, Don. I think if you just looked at the economic value or fair value even of the loans that we have on the sheet, it would be much higher. I mean, you could 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. But 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, through the earnings statement into equity and increase book value. So that's where it's coming from.

20:42 Is there anything to the NPL improvement? We should just expect to see that slow improvement throughout the year. That's just sort of the pace.

20:52 Yeah, I think that's our expectation. It's slow and steady. It's going to take a while. 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 work themselves out.

21:11 Thank you.

21:12 Yep. Our next question comes from Aaron Zyganovich with Citi. Please go ahead.

21:22 Thank you. The production volume number was impressive for the quarter, particularly in the investor one to four side. Is that just indicative of a change in demand, or has there been some changes to your marketing to get that higher level of volume?

21:46 Yeah. Hi, Aaron. Good to hear from you. That's, I think, it's a function of kind of both. We think it's increased demand, but also no change to our programs, but I think just operationally kind of hitting our stride and kind of getting back in the groove. And then also there's a little bit of seasonality in there that kind of January, December, January, year-end stuff, you know, can always bounce around a little bit. So I think all three of those combined add to the growth. But we definitely see... Across the board, our account executives are being more productive, and that's not from changing our guidelines or new programs.

22:32 That's just their inherent productivity.

22:36 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?

22:53 Yeah, 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. We saw a lot of apps. So I'm pretty optimistic that it's going to come back to somewhere at that level. We did raise our credit minimums and tighten the box a little bit. 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.

23:30 Okay. And then just lastly, kind of following up on Don's question, when we look at the breakdown on slide nine 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, but I know that sometimes some of the judicial states can take years. I'm just trying to think about how long some of this might hang out.

24:07 Yes. What you see is the delinquency kind of quickly rolls 30, 60, 90, and then into foreclosure, and then, to your point, sits in foreclosure quite a while because that's where it depends on how fast we can get through the various state processes. But on average, we're running about 10 to 11 months in foreclosure. in that foreclosure status before we see a resolution. So that doesn't mean that it's a quote-unquote foreclosure sale. It just means finally that the loan either comes current or gets paid off. And so, you know, in some of the longer states you have borrowers who, you know, you just see it, they wait until the very last minute and then they reinstate or pay us off.

24:59 And then, you know, you can have a short state like Texas where you can foreclose in 60 days. So To your point, it varies across the U.S., but on average 10 months or so is what we experience.

25:14 Okay. Thank you. Yep. As a reminder, if you have a question, please press star then 1 to be joined into the queue. The next question comes from Chris Mueller with JMP Securities. Please go ahead.

25:31 Hey, guys. Thanks for taking the questions. I'm on for Steve today. They hit on a couple of things I had, but I guess just a follow-up on origination volumes. I guess once we do reach that normalized market, do you think the volumes will be closer to that 30% in each bucket breakout, or do you feel like the SFR is going to be a heavier weighting going forward?

25:56 Yes. So on the short-term product, that's all One to four. So it'll skew more heavily to the one to four because we don't offer that short-term product for the commercial assets yet. We may offer that sometime in the future, but right now it's all one to four.

26:19 Got it. And then on the other side of the equation, do you guys have any expectations for repayment levels for this year?

26:27 We don't. We don't try to forecast that. It's kind of too tricky to do so. We're, you know, accruing default interest while it happens, so whether it happens this week or next week or next month, you know, we're somewhat indifferent because it's very profitable for us, and it's lumpy. It's very hard to predict, so we don't try to forecast that.

26:55 All right. Thanks. I had to ask you anyway, and

26:57 I just want to add in there, when Chris said we accrue for default interest, let's be really clear, Chris said we accrue it when it happens, meaning we record the default interest on a cash basis. We don't reserve or accrue for it. We just book it when we receive it.

27:10 Right, and you're right. 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. Right.

27:27 Thanks for taking the questions. This concludes our question and answer session. I would like to turn the conference back over to Chris Ferreira for any closing remarks.

27:43 Thank you all for participating. We appreciate it and look forward to our next update after Q2. Thank you.

27:51 Thank you, everybody. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.