Velocity Financial Q3 2023 Earnings Call Transcript

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November 2, 2023

There are 7 speakers on the call.

Operator

Good day, and welcome to the Velocity Financial Q3 2023 Conference Call. All participants will be in a listen only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Mr.

Operator

Chris Altman. Please go ahead.

Speaker 1

Thanks, Rachel. Hello, everyone, and thank you for joining us today for A discussion of Velocity's 3rd quarter 2022 results. Joining me today are Chris Farrar, Velocity's President and Chief Executive Officer And Mark Zapani, Velocity's Chief Financial Officer. Earlier this afternoon, we released our Q3 2022 results And the press release and accompanying presentation are available on our Investor Relations website. I want to remind everyone 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.

Speaker 1

For a discussion of risk and other factors that could affect results, please see the risk factors and other cautionary statements made in our communications with shareholders, including the risk factors disclosed in our filings with the Securities and Exchange Commission. Please also note that the content of this conference call contains time sensitive 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.

Speaker 1

And with that, I will now turn the call over to Chris Farrar.

Speaker 2

Thank you, Chris, and I'd like to welcome everyone to our Q3 earnings call. Earlier today, we released the results from a strong quarter as We continue to execute very well on our growth strategy. Our core earnings increased 29% over the prior year quarter, which is quite impressive Despite the uncertainty and various crosscurrents, we expect to continue to take market share and expand our portfolio. For a long time and our team is well positioned to capitalize as we've spent the last 19 years building our platform to shine in times like this. Our pipeline is strong and growing, which allows us to be selective in extending credit as well as increase our coupon.

Speaker 2

In terms of our portfolio, we experienced minimal charge offs this quarter and our special servicing team Real Estate Markets in Single Family Rental and Small Cap CRE are healthy in terms of valuation and outperform We believe our focus on small properties with neighborhood serving essential services will continue Very busy in the capital markets completing 2 securitizations in Q3 and we just priced our last deal of the year on Tuesday of this week. One of those securitizations is an inaugural transaction collateralized by our short term loans with a revolving structure that allows us to replace loans We also collapsed the last of our older sequential pay deals during the quarter. Our track record Strong credit performance allows us to access the capital markets efficiently and enjoy support from a broad base of fixed income investors. The other significant policy change we made during the quarter was to hedge our future debt issuances backed by newly originated loans. Very fortunate in our timing as we offset most of the move in the underlying base rate treasuries before we priced our deal earlier this week.

Speaker 2

Hedges are cash flow hedges that will accrete into our income statement over time in support of our strategy of achieving a stable, predictable NIM. We will continue to hedge future debt issuances before we securitize as a good risk management practice. Regardless of uncertainty about interest rates, the economy and other events outside our control, we will grow and be opportunistic. Our strategy is to remain nimble and lean Our many years of experience to navigate whatever comes our way. I want to congratulate all our team members on another great quarter.

Speaker 2

Our people are our greatest And we will continue to work hard for all shareholders. That concludes my prepared remarks and I'll turn over To the earnings materials, starting on Page 3, as I mentioned, strong growth in Core net income, very positive quarter there. Stable NIM, up 10 bps from the prior quarter. We continue to put on new production coupons that are attractive in terms of our historical spreads. And then I also mentioned the hedge strategy, which didn't affect earnings for Q3.

Speaker 2

It will Show up in our future deals as I mentioned that over time as we issue those transactions. In terms of production and the loan portfolio, October was a record month for production where all throughout the year We've seen volumes grow even while we're raising coupons. So we're very encouraged there and like the trends. In terms of NPLs, we were flat quarter over quarter and continue to realize positive gains as we resolve assets. Our team is doing a great job there.

Speaker 2

On financing and capital, I mentioned the 2 securitizations. We're excited on the Short term product to be able to term out those loans and create that revolving structure. So we've got additional capacity to grow that product going forward. In terms of warehouse and liquidity, we're in good position there to support future growth. Turning to Page 4, very nice build in book value per share.

Speaker 2

You can see we're up $0.43 Q over Q It's a combination of portfolio earnings as well as other additional income generated in the quarter. Turning to Page 5, shown this slide for a number of quarters now and Try to demonstrate that we believe there's a significant amount of embedded equity in platform. And One of the changes you'll note if you compare this to the prior quarter is the embedded gain in the securitized portfolio has grown pretty significantly That's a result of us slowing our assumptions on prepay speeds. So, we did that during the quarter. And As we assume slower prepay speeds, that's obviously going to extend out the portfolio and increase future earnings.

Speaker 2

So we think There's a real good story here around the economic value of the equity that we've built in the platform. So with that, I'll turn it over to Mark to continue in the presentation.

Speaker 3

Thanks, Chris. Hi, everyone. Thanks for joining again 3rd quarter earnings call. On Page 6, loan production continues to improve during the year even with the current high interest rate environment. As you can see, Q3 production was almost $291,000,000 in UPB, which is a 12.3% increase over Q2 And almost a 34% increase from our Q1 production.

Speaker 3

And the strong production growth during 23 has occurred with the weighted average coupons for new originations for all three quarters remaining constant at about 11%. The strong 2023 production growth at the Hyre Wax continues to demonstrate borrower demand for our products. As a result of the strong growth in production, on Page 7 shows a similar growth in our overall loan portfolio. Our total loan portfolio as September 30 was almost $3,900,000,000 which is a 4% 4.2% increase from Q2, almost 13% increase on a year over year basis. The weighted average coupon on our total portfolio as of September 30 was 8.63%.

Speaker 3

That's 23 basis points higher than at the end of Q2 and 92 basis points higher year over year compared to Q3 of last year. And while our loan portfolio is growing, our loan to value ratio remains consistent on the overall portfolio at 68%. And 2023 production, the LTV has actually averaged a little lower at 66%. On Page 8, our 3rd quarter NIM increased 10 basis points over Q2. Our portfolio yield increased quarter over quarter by 14 basis points, while our cost of funds only increased by about 5.

Speaker 3

So not only are we seeing growth in production, but we're also seeing an increase in our NIM. On Page 9, our non performing loan rate Q3 was flat to 10% compared to Q2 and the ongoing strong collection efforts by our own special servicing department, As Chris mentioned, has continued to result in resolutions of our NPL loans at favorable gains. If you look at Page And it highlights the continued success of our NPL resolution efforts. In Q3, we resolved $65,700,000 UPB of NPL loans for a net gain of $1,200,000 Although not on this slide, if you take a look at all of 2020 3, so for 2023 year to date through September 30, we've resolved over $154,000,000 of UPB of NPL loans for a total gain of $4,000,000 Page 11 presents our CECL loan loss reserve and loan charge offs. The CECL reserve as September 30 was $4,700,000 or 16 bps of our outstanding loans held for investment and amortized cost balance.

Speaker 3

Our CECL reserve has been very consistent at 15 to 16 bps over the last 5 to 6 quarters. And keep in mind, the The loan loss reserve does not include our loans being carried at fair value. It's the loans at amortized cost. Q3 charge offs are also shown in the right corner on Page 11. For Q3, they're only $95,000 and our charge offs have And another $31,000,000 in available liquidity on our unfinanced collateral.

Speaker 3

As Chris mentioned, we did Q2 securitizations in Q3. In July, we issued the 2023 RTL-one secondurity with about 81 point $6,000,000 of securities being issued. Chris mentioned this is a very noteworthy security for us because it was the first security ever issued by Velocity that's collateralized by our short term loan product. Security is a fixed rate security with the reinvestment period where newly originated short term loans can be added to the security as the existing loans pay off. This new type of financing for us demonstrates further diversification and financing options for Velocity and it's another type of cost effective non mark to market financing.

Speaker 3

In August of the quarter, we issued the 2023-three secondurity collateralized by our long term loan product, Almost $235,000,000 in securities issued. And as Chris mentioned, in tandem with this long term security, we collapsed one of our older securities 2016-one, that was an older higher cost debt. The 20 sixteen-one secondurity is one of the older sequential waterfall securities, Where the higher rated low cost tranches paid off first. So as those things paid down, they became more expensive. Remember in 20 'seventeen, we started doing the pro rata, where the tranches all pay off kind of evenly.

Speaker 3

So it's nice to be able to collapse one of those securities that got more over time and take that freed up collateral, loan collateral and bring it into the 2023-three seconduritization at a lower cost. Finally, available warehouse line capacity as of September 30 was almost $595,000,000 and Total maximum mine capacity of 810,000,000. So with that, I'll turn it back over to Chris to go over the Economic outlook.

Speaker 2

Thanks, Mark. On Page 13, just a high level overview of where we're headed. As I mentioned at the beginning, the market continues to be strong in terms of valuation and when we price REOs and assets, if they're Right. They moved quickly. We expect to continue to see positive gains from the portfolio there.

Speaker 2

Still a murky economic outlook with lots of Predictions and expectations, but we feel like we're well positioned regardless of which way things break based on our Prior year's experience in our low LTVs. I did mention that we're starting to see prepay speeds slow. So that will Actually be an uptick for us in future income and help us in growing the portfolio on more scale. In terms of capital, mentioned that we already that we priced the last deal of the year and And lastly, I just from an earnings I really think that this theme of tight credit is going to help us and be a tailwind for us as we grow going forward. So that concludes our prepared presentation, and we'd like to open it up for questions if there are any.

Operator

Thank you. We will now begin the question and answer session. Your first question comes from Stephen Laws with Raymond James. Please go ahead.

Speaker 4

Hi, good afternoon. Another nice quarter, so congratulations on that. Chris, I wanted to get an idea about your pipeline, right? October strongest month, I think in a year and I think the same for Q3 volumes for the most in I think 4 quarters. Can you talk about production outlook?

Speaker 4

Where do you see is October pace the new normal or kind of how do you think that plays out? And then any seasonality to the production numbers around year end?

Speaker 2

Yes, sure. So I think the Q4 will be our strongest quarter of the year. November is always a little late because of the holidays of Thanksgiving and whatnot, but December is always a good month for us as people try to close everything by the end of the year. So I think I expect it to be our strongest quarter. And then Next year, I think we're on pace for significantly higher volumes than what we did this Your Q1 again January February starts off a little slow, but builds.

Speaker 2

So We think the run rate in October is Probably a touch high if you wanted to use that on a forward run rate for every month, but not too far away from that.

Speaker 4

Great to see the strong volumes look like they'll continue. And can you talk about terms on these new originations? I don't think you're probably pushing coupon as much as you could given less competition, but can you talk about some other places where you focus to Really high quality for the new production on the underwriting side?

Speaker 2

Yes, sure. Thanks, Stephen. So, yes, one of the things that we are seeing is some of these borrowers come to us with a little bit larger loan sizes. We've been able to capitalize there where someone coming to us with a $3,000,000 or $4,000,000 $5,000,000 loan Historically, it would be at a bank and we wouldn't even get a crack at it and we're seeing those folks. They tend to have Higher credit scores and a little stronger balance sheet.

Speaker 2

So we put a number of those assets on here At the end of the 3rd and start of Q4. So we think that trend will continue as we move forward.

Speaker 4

Great. And last one. Mark, you touched on the new securitization with the replenishment feature, the reinvest period, Which sounds fantastic and congrats on getting the last sequential pay deal done. I remember when we were first talking about those years ago and that

Speaker 3

they would eventually all delay.

Speaker 4

But can you talk about the reinvest period, the benefits of that with new production? I mean, how What's the expected life on loans? So how often will that turn? And how do we think about deal expenses as we amortize those over a longer period of time given a longer expected life? Thank you.

Speaker 3

Yes. On the short term loans, those loans are mostly anywhere between 18, 24 month loans. So 18 to 24 months, the average life gain would be anywhere 12 to 15 months, somewhere in that range. And this is an 18 month reinvestment period, So any new loans originating as the original loans in the deal start paying off, remember those are interest only, short term interest only loans, so the principal is paid at maturity. So as they're paying off, then we can replace them with the new loan.

Speaker 3

What it helps us with is we don't have to go to market to finance them, right? We have to go and do a whole new securitization and incur a bunch securitization costs again, just to kind of re add them and continue to keep that financing out there. So that's a big plus for us. And in terms of the deal cost, Keep in mind, all the loans that we're doing now, we are applying fair value accounting to. So on all the origination costs, and if there were deal costs, we don't For amortizing anymore on the fair value loans, you have to recognize those costs upfront.

Speaker 3

In the short term loans, we are applying fair value to Just as we are in the long term ones.

Speaker 4

Great. Appreciate you highlighting that. Appreciate the comments this afternoon. Thank you.

Speaker 2

Thanks, Steven.

Operator

The next question comes from Sarah Barcomb with BTIG. Please go ahead.

Speaker 5

Hey, everyone. Congrats on the quarter and thanks for taking the Question. So you had another quarter of strong gains on those NPL resolutions. I was hoping you could give a little bit more Context on your outlook for NPLs and resolutions on the NPLs, if we kind of assume that We could see another rate hike in that we're in this higher for longer QT cycle, Higher interest rate backdrop through next year. Can you give your outlook on how that might evolve?

Speaker 2

Yes, sure. Hi, Sarah. Thanks for joining. I think we feel very good about the outlook there. There's a lot of capital on the sidelines for these assets and when we go to sell them either at the foreclosure steps or when we market, We see good activity, a lot of cash buyers.

Speaker 2

Our view is that the rate hikes are not going to have a huge impact on the value of The recoveries that we're getting right now, we expect those to continue. I think if we saw the Economy really start to tank and high unemployment and stress there, that probably would change my outlook or projection, So I think it's as long as we continue to see strong economic activity, we

Speaker 5

And then, I was just thinking about next year, I was hoping you could talk a little bit more about the value and The earnings outlook for that fee based income coming out of the Century portfolio And the value of the HUD license there, just hoping you could kind of highlight that to investors a little bit.

Speaker 2

Sure. Yes, we're very excited with what's going on there. We spent this year really building out the team Developing some muscle there and we've got a great team of originators that we've Increased and our pipeline is very robust. So we didn't do a lot of loans this year, but I think next year is going to be quite robust and expect to see some Very nice gain on sale income there, which is from our perspective is great because it's high ROE And then also builds the servicing book. So I'm very bullish on the opportunity for next year as they pull this

Speaker 5

Great. Thanks so much for taking the questions and congrats again.

Speaker 2

Thanks, Sarah. Appreciate it.

Operator

Your next question comes from Steve Delaney with JMP Securities.

Speaker 6

Thanks and good afternoon everyone, Chris, Mark and Chris. Hi, Steve. So Curious about the bridge lending and it's great that you've got that new product working for you. Is there I'm trying to think at this point in the market and with Rates where they are and maybe, I guess, maybe going higher until today. Are you detecting, Chris, that there's a some sort of a rate strategy on the part of borrowers that if they've got a project underway, are they just Buying time to go refi into another floater and then hope the long end comes down in the next 1 to 2 years before locking in to permanent.

Speaker 6

Just curious if there's anything, any game and ship like that going on? Or do you think the bridge lending It's more organic just in the form of new projects starting up and entrepreneurs actually just

Speaker 2

Yes, sure. It's a good question. I think we see a lot of the former that you posed, but most of those we end up passing Because it kind of feels to us like somebody who's distressed or stretched in and probably not a good risk. So we kind of pass on The ones that we end up doing and we see that are most successful are the more seasoned Experienced, flippers who know their markets and there's still a lot of aged housing out there that needs to be rehabbed and

Speaker 6

Okay. So it's nice to hear that activity is still Running along nicely for you. Curious why I was looking at Page 11, maybe it's An anomaly, but it appears that the charge offs were down a good bit. Trying to Get a handle on why that would be necessarily, just looking at your where you are in the 3rd Quarter versus the 1st 2 quarters of the year.

Speaker 2

Yes. Mark, do you want to handle that one?

Speaker 3

Yes. On that one, if you recall, on our Q2 earnings call, in the $716,000 charge off, there was 393 dollars that, that charge off probably should have been less by $393,000 There was a borrower payment that came into our servicer of $393,000 That lowers carrying guys alone. They're both to lower the charge off. But we didn't get the information from the servicers after we closed out the quarter, and that was 39 Sorry, it's immaterial to our total P and L. So we just said we'll book that recovery in Q4.

Speaker 3

So that's what you're seeing there, Steve. So if you really want to normalize it, You'd lower the $7.16 by $3.93 and put it in Q3.

Speaker 6

Oh, got it. Okay. Well, thanks. I wasn't aware of that anomaly. No trend there.

Speaker 6

I would have been surprised if it was going down that much anyway. So thanks. And just one final thing. Yes, not a bit surprising obviously to see NPLs going up year over year to about 10%. Chris, I guess when you're looking at these situations, is there one primary cause of this or is it multiple?

Speaker 6

I mean, The cost of carry is the first thing that comes to my mind. It's just a heck of a lot more expensive to be a borrower these days. But we're also running into problems with Terminal fair market value of properties are the problems with borrower execution. Just curious kind of looking back anecdotally, When you look at your set of workout loans, problem loans, is there one major Dynamic that you would point to?

Speaker 2

Yes. Good question, Steve. There is not one dynamic that I would point to. I do agree with you completely. There's a lot of cost burdens on borrowers.

Speaker 2

We're fixed rate loans, so I think we've helped them in quite a bit there. But if someone's getting behind and they're starting to dig a hole, it's hard to get out of it. The interesting thing that To me that I would sort of add to that or that I see out there is I think the Most significant part of that uptick, just anecdotally, I don't have hard data for you, Just being in the business and close to it and talking to our asset managers. Yes. Is I think we're seeing a lot of people that were speculating Get flushed out, particularly on the 1 to 4 side, borrowers who saw a show on TV and said, I'm going to flip some homes and found out It's not quite as easy as they maybe thought.

Speaker 2

So I think we're seeing that on the 1 to 4s. On the small commercial assets, the Delinquency rates are actually lower there than they are even in the 1 to 4s and they're holding up extremely well. So I think it goes to kind of like I said that neighborhood serving characteristic that are still in high demand, but definitely Seeing some of the speculators get washed out on the 1 to 4s.

Speaker 6

That makes perfect sense. Well, thank you so much for the comments and Great quarter, another great quarter in an extremely challenging market out there.

Speaker 2

Thank you, Steve. Appreciate it.

Speaker 3

Thanks, Steve. Appreciate it.

Operator

This concludes our question and answer session. I'll now hand it back for any closing remarks.

Speaker 2

Nothing Further, thank you all for joining, and we'll talk to you next quarter.

Speaker 1

Thank you, everybody. Appreciate your time.

Operator

The conference call is now concluded. Thank you for attending. You may now disconnect.

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Earnings Conference Call
Velocity Financial Q3 2023
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