Velocity Financial (NYSE:VEL) Q4 2020 Earnings Call

0:01 Good day and welcome to the Velocity Financial, Inc. Fourth Quarter 2020 Earnings Conference Call. All participants will be in a listen-only mode. Should you need assistance, please signal conference specialists by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touch-tone phone. And 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, sir.

0:32 Thank you, Chuck. Hello, everyone, and thank you for joining us today for Velocity Financial's fourth quarter 2020 earnings call. With 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 fourth quarter 2020 press release and 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 discussions 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.

1:23 Also note that the content of this conference call contains time-sensitive information that is accurate only as of today, and we do not undertake any duty to update forward-looking statements. We may also refer to certain non-GAAP measures on this call. For reconciliations of these non-GAAP measures, you should refer to the earnings materials on our investor relations website. And finally, today's call is being recorded and will be available on the company's website later today. I would like to turn the call over to Chris Farrar for opening remarks.

1:57 Thanks, Chris. Appreciate it. Welcome, everyone, to the Q4 earnings call. As you can see from our press release, we obviously had a very strong quarter to finish the year, and we're really proud of the fact that we overcame the difficult challenges we faced in 2020 so well. Despite elevated delinquency levels, our portfolio continued to provide positive income in all four quarters and we also improved on last year's net income, which is really impressive under the extreme conditions we faced. Our people are so important to our business and I want to thank every team member at Velocity who worked so hard to quickly adapt to the rapidly changing world that we all faced. From a macro perspective, we continue to see strong real estate values in most parts of the country. Fortunately, we have no credit exposure for the types of commercial properties that were most hard hit, i.e., hospitality, movie theaters, and standalone restaurants.

2:53 On the residential side of things, we're starting to see many states roll out tenant and or landlord relief for those impacted by the pandemic, and our special servicing team is sharing relevant information with our borrowers as it becomes available. We hope that these programs will allow folks to survive the difficulties they've encountered and get back on track. Tremendous government stimulus and low interest rate environment that's been a strong backdrop for real estate in general, and we continue to see impressive origination, demand, and healthy functioning real estate markets. Turning to velocity more specifically, on the asset side, we saw increased delinquency as well as an increased level of payoffs and cured loans. So we still see some borrowers struggling with the impacts of the epidemic, obviously, and other borrowers are catching up or paying off entirely.

3:46 Overall, Q4's activity was much higher than Q3 as we see markets starting to normalize. Fortunately, we realized very strong recovery rates in the quarter and we're very pleased with the quality of new lending opportunities that we see. On the liability side, we recently completed two important financing Design to minimize mark-to-market risk and provide us with new growth capital. More confident with our risk profile now as a result of these important changes and excited to put this capital to work. We're well positioned to organically grow our business with a more stable funding base. As always, we appreciate your continued support and want all investors to know that our entire organization is focused on performing for our customers and and delivering real value to all stakeholders.

4:39 That concludes my prepared remarks and now we'll turn to the presentation materials. On page three of the Q4 highlights, I'll hit the first page here and then turn the presentation over to Mark and wrap it up at the end. But again, really great quarter for us, strong net income and EPS. The big differentiator here that's a little bit unusual for us is that we sold just under $100 million of loans in the quarter. Typically, we don't do that. We aggregate everything, obviously, for securitization. That was really driven by two factors. One, we had some very, very attractive prices, and two, we really wanted to be prudent with our liquidity and manage that well up until the point where we got the new corporate debt done.

5:29 So that was the drivers for kind of the change in the quarter. That gain on sale really boosted the earnings over and above our normal just kind of portfolio income. Also importantly, you saw NIMS increased in the fourth quarter, again, as our special servicing team continued to drive good, strong recovery rates. yields that were higher even though we had an uptick in delinquency. So again, very strong recovery rates on delinquent assets is driving that NIM wider. In terms of production and the portfolio, really good fourth quarter of $179 million in new originations.

6:16 I mentioned the strong resolutions. We got 103.5 in terms of recovery rates. So again, still making money over and above the contractual interest that's due. So good results there. And then as I mentioned in my opening remarks, non-performing loans did tick up to $332 million. Seeing the majority of that is really driven by my folks that were given forbearance and then unfortunately have gone back to delinquent status. So even though we had a A lot of assets resolved favorably. We are seeing some people still fall behind. And then again, I guess just to kind of wrap up here from the financing and capital perspective, we added a $200 million non-mark-to-market warehouse facility.

7:09 So that was a great achievement for us. really helps us minimize any risk going forward as we aggregate for securitization. We closed that in February and then also entered into the new syndicated term loan, which we've got some really great partners there that are supporting us. And that transaction gave us roughly $80 million of growth capital going forward. So we've got a couple of years of capacity here as we continue to grow the portfolio and make more loans. So that's kind of a high-level wrap-up on the quarter. I'll turn it over to Mark on page four to take you through the rest of the presentation.

7:53 Thanks, Chris. Hi, everybody. On page four, I'll go over the earnings for Q4. From a pre-tax standpoint, as Chris mentioned, a very strong quarter for Velocity Financial, $11.7 million in total pre-tax income for the quarter. $7 million of that was generated by the in-place portfolio. We talked about the in-place portfolio and the fixed spread that we generate off that portfolio. So again, nice earnings from that portfolio, $7 million for the quarter. A lot of that, some of that also being the default interest and prepayment fees. We're going to see in a couple slides the resolutions that we had on the MPL loans. As Chris mentioned on these non-performing loans, we still have strong resolutions at a gain where we collect all contractual principal interest.

8:39 as well as default interest and sometimes prepayment fees as well. So we'll see that in a couple of slides again. $4.7 million of the 11-7 was gained on sale loans. As Chris mentioned, there's a very strong demand for our product in Q4. So because of the strong demand for the product as well as wanting to make sure we have plenty of liquidity for the originations and the pipeline volume that we saw coming through as we were working on this corporate debt deal, as Chris mentioned, this $175 million debt deal that came through in February, So we wanted to really strengthen our liquidity position, have strong proof of liquidity. So we did sell about $96 million worth of UPB in Q4, generating that $4.7 million gain. We sold a little bit more in January.

9:24 Again, just again, this market was strong, a lot of short-cut liquidity. When this debt deal came through in February, our goal now is to kind of get back to our basics of originating loans and holding loans in our portfolio, and then putting them into long-term securitizations and locking in that fixed rate spread. So we'll opportunistically look maybe to sell loans once in a while, but the main goal is to kind of follow the business model that we've always had in terms of holding these loans for securitization purposes. The book value per share on the same page to the right increased from $10.44 a share at the end of Q3 to $10.93. On page five, Chris kind of mentioned the volume picking up again in Q4. So you can see in Q1 we had about $248 million in volume.

10:11 Then you see the second and third quarter was basically the suspension of loan originations during the pandemic and then starting up our origination platform again with a full quarter of originations in Q4. As Chris mentioned, $179 million. The originations in Q4 was all of our 30-year product. There was no short-term product in those originations. We're currently not offering the short-term product. We're just kind of watching the market and looking at the appropriate reentry points to start offering that short-term product. But as of now, we're still offering the 30-year product. On page six, showing our health for investment loan portfolio. To the left, you see the loan portfolio composition. Basically, all health for investment loans, as you can see.

10:58 You can see the loan portfolio at the end of Q4 came down slightly from Q3 and from end of year 2019. And as was mentioned, that's mainly because six months of no originations, just starting up again in Q4. So for 2020, the principal prepayments and some of those sales in Q4 were greater than the amount of new loans put on.

11:20 So you had a little bit of runoff that portfolio.

11:22 But now that we're back to fully origination again, we expect to be adding to that in-place portfolio on a fixed rate spread on a go-forward basis. and then the right side of that is just kind of showing the waterfall on the loan portfolio from Q3 to Q4. And you see I'm talking about the principal prepayments and loan sales kind of exceeded the loan production for the quarter. Page seven is our non-performing loan resolution activity. And as Chris had mentioned, very strong resolution activity. See in Q3, we resolved $12.5 million of total UPV non-performing loans. almost two and a half times that for Q4, $30 million of resolution and a $1.1 million gain for the quarter of those resolutions.

12:08 So you can see even for Q3 and Q4, bringing in about a three and a half point gain on our NPL resolutions. So we're kind of really following our historical resolutions on non-performing loans. We've said that over 90% of our non-performing loans either pay off or pay current. And when it does that, we collect not only 100% of the contractual principal and interest, but also default interest. And in many cases, depending on when the loan's paying off, prepayment fees on top of that. So that's what's generating that 3.5% gain for Q3 and Q4. You'll see in the 10-K that we had a 3.5% average non-performing resolution gain for the entire year of 2020. So we did average 3.5% the whole year. So it's very steady and consistent.

12:53 and as Chris mentioned, that's why the non-performing, the kind of uptick in that because of the pandemic hasn't been that troubling to us because historically we've always made money on these non-performing loans and we continue to do that straight through all of 2020. Page eight just shows the net interest margin. Over to the left side for Q4, our net interest margin was 4.07%. An improvement over Q3 of 3.77. and again, we just saw the resolution activity. So on Q4, strong resolution to 30 million, bringing in a three and a half percent gain default interest prepayment fee. So that helps the net interest margin and all goes into the margin. So part of the reason for the uptick there. To the right, you can see kind of the components of net interest margin.

13:40 So the top line is the loan yield. So as I said, loan yield went from 821 to 840 from Q3 to Q4, but also the debt cost, overall average debt cost improved as well. So a widening of the margin, which is really a good sign for us going forward. On page nine, loan portfolio performance. Chris mentioned the uptick in the non-performing. So you see at the end of Q4, just a little over 17% compared to the 15.8 for Q3. And the main reason for that, as Chris mentioned, was loans that came out of our COVID forbearance program that then missed their next three months payments coming out and then were put on non-performing. So the forbearance program ran through April through June, where we gave them a 90-day forbearance. So then if they're going to miss three months after that, that's going to end up right in Q4. And that's one of the main reasons for the uptick.

14:35 Going down to January and February, that has pretty much leveled off. We don't see any more uptick going in right now. And we expect to start working through that. As you saw, $30 million in Q4. We're working on resolving those NPL loans. Our overall charge-offs remain very, very consistent. You can see from 36 basis points for Q4 of 19, 33 basis points Q3 of 20, and 37 basis points Q4 of 20. So we've been very consistent. And the 35 basis points of non-performing loans, that's been consistent with the two, three-year historical trends. So very consistent over time on our charge-offs, very little charge-offs. And on page 10, in terms of the loan loss reserve, we've mentioned that we've implemented our CECL reserve on the 1st, January 1st of 2020 under FASB GAAP.

15:27 And because of the COVID pandemic, we felt it was prudent to increase that reserve in light of the pandemic and the non-performing increasing, it was prudent to increase that reserve during Q1 and Q2. And you can see we did that, went from 2.3 million starting out the year to 5.2 million at the end of Q2, 28 basis points. And we felt that that was probably a very good level of reserve to have. And we've kind of maintained that level over the second half of 2020.

15:55 So for Q3, Q4, it's gone up, you know, one or two basis points.

16:00 So at the end of the year, 30 basis points, $5.8 million in reserve. And again, based on the low charge off level and still with 3.5% gain, we see on resolving the NPL loans, We feel that we're very comfortable with that reserve where it's at right now. Chris, I'll turn it back to you if you want to talk a little bit about Velocity's outlook for 2021.

16:25 Great. Thanks, Mark. Appreciate it. Just to kind of finish up the presentation here, you know, from an economic perspective, obviously we're hopeful that we'll start to see things reopen and the economy start to get back on track and We're expecting to see good growth as we go forward. We think we'll be able to take advantage of that and build on that by originating more loans, and we're seeing really good lending opportunities there, so we're encouraged by that. From a portfolio perspective, hoping to see that begin to normalize and start to trend down in terms of delinquency. I think we've been very conservative with our loan loss reserves in case things don't go the way that we hope, but I think in talking to our special servicing team, we're seeing good resolutions and expect to start working off kind of that backlog of loans.

17:27 And lastly, obviously, mentioned that we've got the capital in place to fuel our growth, and so we're very We've really, I think, strengthened the balance sheet and the business to grow going forward. That wraps up all of our prepared marks and presentation. With that, we'll, I guess, open it up 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.

18:15 If you're using a speakerphone, please pick up your handset before pressing the key. And to withdraw your question, please press star then 2. And at this time, we'll pause momentarily to assemble our roster. and the first question will come from Aaron Siganovich with Citi. Please go ahead. Thanks.

18:39 Maybe just touching on the new production, it looks like you're on pace to do around 190 million if we use the first two months as a gauge. That would be a bit of a decrease from the year-over-year but a modest increase from the prior quarter. You don't have the short-term product which is, you know, the primary impact there. What's your expectation for new production for the year? Will it be around this pace? Are there any kind of seasonal pickups that you would expect in 2Q and 3Q? Just some thoughts on that.

19:15 Sure. Hi, Aaron. I think our guidance has been we expect to do $1 billion for the year. Q1 is usually seasonally a little light, January and February a little bit light. I think March will be at a stronger level than we saw in January and February. So I think we do expect the quarterly production numbers to grow from this level, and we think a billion dollars is very doable for the year. As Mark mentioned, we'll probably reintroduce the short-term products soon, and that will be another We feel really good about how much capacity and demand there is out there for this product.

20:10 We think this is probably the low quarter of the year.

20:17 And then the portfolio yield ticked up a little bit quarter over quarter. I believe that was referenced as being related to increased collections of non-performing loans and default interest. Is that viewed as an elevated level, or do you expect this to kind of stay at this level as you're continuing to work through some of these loans?

20:40 Yeah, that's a really good question. It's very tough for us to forecast because it is so lumpy. It just depends on when assets resolve. So whether they'll fall in the first quarter or the second quarter is tricky for us to forecast. But I think we like to build our model and our projections kind of in the low eights. You'll see it bouncing around in there from 8 to 8.5 depending on the timing of when some of these loans resolve. Sometimes we have a loan that's been delinquent for two years and you'll obviously have a big catch-up on a loan like that. Other times you'll have a loan that's only been delinquent for 120 days and it's not as impactful.

21:31 And Aaron, this is Mark. There's a little bit of trade-off there as well because when the loans are going non-performing, We don't accrue interest. That's why we call them non-performing, right? So we're not accruing interest to the financials, but then as Chris mentioned, as our special servicing department is working with the borrowers and getting them to pay current, and then we receive that cash. As we get the cash interest and the default interest, we're then booking that actual cash receipt to the financials. So you're right. As they start catching up, there may not be as much cash coming in, but then if they catch up because they're paying current, once they go to current, there's not as much lumpy cash coming in, but then we're back to accruing the interest. So that accruing interest is hitting the financial statements once again. So there's kind of a trade-off there.

22:13 Yeah, that's a fair point. Okay. And then on the cost of funds, maybe discuss the new financing that you've added, the non-mark-to-market, obviously, a big positive, but how is that going to impact your expectation for cost of funds as you roll through 2021?

22:36 Yeah, so we're definitely going to have a higher cost of funds on the corporate debt side, obviously, because we upsized there. So that will be a drag on this year's results. But we thought it was the most attractive capital to grow the business, so we don't have to do an equity raise or anything like that at the levels where we're trading. So It will be an earnings drag this year, but as you've seen when you build the model, production that's put on this year fully scales into the following year. So it will be a bit of a headwind for this year. Next year, we should see very strong growth.

23:24 Okay. All right. Thank you. The next question will come from Stephen Laws with Raymond James. Please go ahead. Hi, good afternoon.

23:37 Nice end of the year, especially with opportunistic loan sales. You know, wanted to touch base, really follow, you know, Aaron's question of the financing costs, but more on the portfolio side. You know, the older sequential pay deals, looks like they're, you know, a couple of them are below 20%. Are there opportunities to call that and re-securitize them at lower costs, or do you have, you know, how do you expect those to pay down and change the mix of funding costs in 21?

24:05 Yeah, so we absolutely do have that opportunity. It's a little bit tricky to predict exactly, but we will definitely in the next 12 months pay off a couple of deals, and that will be a good opportunity for us to swap out some funding costs. It tends to be smaller balances, so it's probably not a huge impact to our overall costs, and just to give you the backdrop there, when we first started out, our call rates on these securitizations were maybe 5 or 10% of the original deal. As we progressed and got a better track record, those stepped up to 20 and then 25 and 30%. So I don't think there'll be much in the way of a meaningful swap out there over all costs, but as and the business matures, there will be some more significant savings probably in 22, 23.

25:09 Okay, that's great to know just given the cost of those first three deals and where we stand there. But I see your point about the small balance, but it does move it a little bit given the cost. And then to follow up on a comment in the press release, I think it was the shorter term deal, the 20-2 MC1 paying down a little faster than others. Is that expected to continue? looks like it's, what, $138 million. How quickly do you think that pays down as we think about this blended mix?

25:38 Yeah, so the majority of the collateral in that deal is the short-term loans that were kind of 12- to 24-month duration. So we do expect that to be a much faster speed relative to the other deals. So, yes, we expect that to continue throughout the year.

25:59 Great. And then on the loan sales, do you expect to do any of that this year? Now that the facility's closed, the corporate debt's in place, you prefer to retain and do the securitizations that way? Is that something we should expect to see on a recurring basis or not?

26:19 Yeah. We've talked about it quite a bit internally. I don't think you should expect it on a recurring basis. We did sell probably $50 million or so in the first quarter.

26:31 $50 million in January. Okay.

26:34 So in the first quarter, about $50 million. So you'll see that when we do next quarter's results. But on a go-forward basis, we're going to be opportunistic. We have to allocate capital smartly. So if we see a really great price or the right opportunity, we'll go ahead and take advantage of it. But in terms of the way we model the business and the way we're forecasting, we're not counting on something like that.

27:03 Was that $50,000 sold at five points?

27:08 I don't know the exact number, but you can use something probably pretty close to what we used on Q4. It'll be very close to that.

27:19 Five and a half points. Okay.

27:23 And then lastly, you know, you still have a return in the short-term business. You mentioned you continue to watch that market. Can you really, I mean, can you provide a little color on what metrics you're looking at? You know, what is it that you'd like to see before you do start offering that product again?

27:39 Yeah, so it's more driven on the financing side. We're just looking at the securitization and capital markets to make sure that we've got a rock-solid exit in place. And so that's really what we're working on right now. And we've made a lot of good progress there. So I think you'll see us get back in a quarter or two.

28:02 Great. Well, thanks for the comments this afternoon. I appreciate it.

28:05 Thank you, Stephen. The next question will come from Steve Delaney with JMP Securities. Please go ahead.

28:14 Thanks. Hello, everybody, and congratulations on your reopen and back to more normal times. Great quarter. So my very capable compatriots in the research field, they kind of checked off about six of my seven or eight questions, so they did a great job on their Q&A. I've got a couple things, though. Following up on Steven's question about the bridge loans, in the past, when that was kind of rocking and rolling two or three years ago, what would you say your average quarterly volume in that short-term product was, and if you could give us kind of a range of expected gain-on-sale margin? Thanks.

28:58 Sure. So thanks for that, Steven. We're going to take the second one first. We probably won't do gain on sale there. We'll probably aggregate and securitize.

29:15 In the past, Chris, didn't you normally sell that product? I guess it can always be a matter of opportunistic versus NIMS, but I just thought of it as a gain on sale.

29:26 No, you're right. We did all the way through 2019, and then we started – at the beginning of 20, we stopped selling it and were aggregating for our first securitization. So we kind of took a one-year pause here, and hopefully we'll do that soon. We could sell it for cash, and we may, but the strategy right now is to go ahead and securitize it.

29:52 Nice, okay.

29:53 Yeah, and then in terms of volume, You know, it was roughly running about 30% of our business. So, depending on what we were doing. So, you know, again, it'll take a while.

30:07 70, 80, could be 70, 80 million a month.

30:10 Yeah, it was significant. So, we'll see how things go as we turn it back on here, but it can be meaningful volume.

30:22 Okay, great. And thanks for the color on the The new financings, obviously, getting a term loan facility is quasi-capital for you in the non-mark-to-market. Thank you for the guidance on the higher cost of funds. I'm curious on the warehouse facility now. With that 200, what is your total warehouse funding capacity at this time?

30:47 We're $350 million today. Okay. will probably put another facility or two in place just to expand that, probably get to like 500,600, something like that on a go-forward basis. And, yeah, and the – we have the two other facilities in place. One's 100 and the other's 50, so that's how we get to the 350 right now.

31:19 Got it. Okay, well, listen – Thanks for the comments. That's great. Amazing to see the stock up 70 plus percent since September 30. And I'm happy. Clients are happy. And keep it rolling in 2021. Thank you. Thanks. We appreciate your support. The next question will come from Don Fandepti with Wells Fargo. Please go ahead.

31:43 Hi, Chris. I was wondering if you could provide your thoughts on the housing market situation. Given that mortgage rates have moved up here and then also the competitive environment for your lending business.

31:56 Sure. Hi, Don. So, in general, obviously, I would say the markets are on fire. I think, obviously, refinancing is probably going to cool off if rates continue doing what they're doing. but we still see strong purchase activity, strong demand there when we have to sell a one to four or if we see people that are facing foreclosure, they're able to sell them very quickly. So I think there's still more demand than supply from our perspective. So we expect that market to stay pretty strong even with rising rates.

32:41 And then in terms of competition, Very fortunate in that we don't have people shopping us a lot, where we have people putting pressure on us to drop rates to match somebody else. I know there are other lenders out there getting share, and that's great. I mean, there's plenty of pie for everyone. But we haven't felt competitive pressures to price our product or do anything like that. I know there's some of the The non-QM lenders out there that are offering products that are similar to ours in the one to four on the small commercial side. Last volume there than we were pre-COVID intentionally. We're just being cautious there.

33:31 So not seeing a tremendous amount of pressure from competitive set right now. Thank you. Sure. Again, if you have a question, please press star, then one. Our next question will come from Mark Cooper, investor. Please go ahead.

33:53 Hi, good afternoon. Thanks for taking the call.

33:55 I was just wondering, the warehouse facility that you have in place, how difficult is it to expand your facility to get more loans done? Thank you.

34:06 Yeah, sure, Mark. Thanks for the question. It's relatively... straightforward our lenders are very supportive and helpful and as we as we reach capacity there they're more than willing to upsize you kind of do it in chunks if you need it we have plenty of capacity right now but I mentioned earlier that we're going to add another one or two credit facilities so that will that will give us another couple hundred million of capacity there but all of the lenders have said they're willing to or have done in the past where they've upsized for us. So there's plenty of capacity there if we need it.

34:49 Okay, and also for further growth, the model of going through brokers, is there another method to get to borrowers other than brokers that you're looking at? Thank you.

35:00 Sure. No, there's not. We exclusively work with brokers. We're built for that model. There are other ways to do it that can be pretty expensive. and so it's nothing that we intend to do on that front. We've got plenty of growth ahead of us with the current model.

35:22 Okay, I appreciate it. Thank you very much.

35:24 You're welcome. This concludes our question and answer session. I would like to turn the conference back over to CEO Chris Farrar for any closing remarks. Please go ahead, sir.

35:38 Thank you. Again, appreciate everybody taking the time out of your day to listen to the call, and thanks for your support. We're going to continue to work hard to grow our business and execute on the plan, so thank you all for joining the call. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.