Optical Cable Q1 2023 Earnings Call Transcript

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May 4, 2023

There are 6 speakers on the call.

Operator

Good afternoon, and welcome to the Velocity Financial First Quarter 2023 Earnings 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 Chris Oltmann, Treasurer and Director of Investor Relations, please go ahead.

Speaker 1

Thank you, Danielle. Hello, everyone, and thank you for joining us Today for the discussion of Velocity's Q1 2023 results. Joining me today are Chris Farrar, Velocity's President and Chief Executive Officer and Mark Cipaniak, Velocity's Chief Financial Officer. Earlier this afternoon, we released our first 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.

Speaker 1

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

Speaker 2

Thanks, Chris, and we'd like to welcome everyone to our Q1 earnings call. Earlier today, as Chris We reported another strong quarter as we continue to grow in a disciplined and profitable way. Our successful matched funding Strategy of locking in fixed rate spreads has held up very well considering the rapid rise in rates. As you're all keenly aware, there's been a tremendous to see these competitors tighten credit or step away entirely from the market, which has naturally led to an increase Lending opportunities for us. We believe this theme will continue to play out for the remainder of the year and we're seeing better borrowers First quarter resolutions rebounded to a more typical rate, which contributed to a 49 basis point portfolio yield increase from Q4 'twenty Perhaps more importantly, we've constructed our portfolio in such a way as to avoid the most problematic commercial real estate assets.

Speaker 2

Over 15% of our loans are secured by single family rental properties and 75% of the portfolio has a residential On the small commercial segment of our business, the properties backing our loans tend to be small neighborhood serving assets that are usually in very high demand. We do not have exposure to large office buildings where other lenders are starting to see significant realized losses. As we look forward, we believe we're well positioned to succeed in a variety of potential outcomes as we experience With respect to growth, we were very conservative with new originations in the 1st part of the year, but have recently started to Although real estate market transactions have slowed, we can continue to see plenty of borrower demand. As an example, we received $3,000,000,000 in new loan requests in the Q1 of 'twenty three and originated just over $200,000,000 in new loans. In adding new assets.

Speaker 2

On the capital markets side of our business, we're pleased to see continued support for our platform as we just priced our second Regular Way deal of the year with strong investor demand. In April, we completed our most significant transaction of the year further growth and provides us a more stable alternative to short term repo financing. Looking forward, we expect continued earnings That concludes my remarks and I'll Pop over to the earnings presentation on Page 3. From an earnings A very clean, simple, straightforward quarter, nice core earnings, slightly below where they were the Prior quarter from last year and I think that speaks to the strength of our business model to be able to absorb all the change that we've seen in In terms of recovery rates, again, another strong quarter of Positive earnings from NPL recoveries, so we're very pleased with those results. And as I mentioned, We're continuing to see our yields increases not only from higher wax on new originations, That bounced back in resolutions on NPLs.

Speaker 2

In terms of the portfolio, things are pretty Healthy there, kind of performing, as I said, as expected. We did reduce volumes intentionally. We In general, and as I said, because we're getting good demand on the securitization side, we're going to increase that production going forward. In terms of financing and capital, I did mention the second securitization that we just priced It went off very well. And as I mentioned, the re REMIC was a really important transaction for us, Generated just under $65,000,000 of new capital that we put into the business, Paid off $15,000,000 of repo that was against those bonds and opened up what we think will be a new avenue As we continue to retain assets in the future, we certainly have the ability To re remake those as well.

Speaker 2

So we're very pleased with the support that we got in the capital markets there. On Page 4, looking at book value, another strong quarter of book value growth as we execute on our strategy Retain earnings and grow book value, you can see we did well there. And on a core basis, There's a little bit of add back here for some of the equity components. On 5, Even though we've got healthy book value growth and on Slide 4, we showed you GAAP book value. We think the economic book value is much higher.

Speaker 2

We believe the embedded gain in our portfolio is not accurately reflected in GAAP book value and that economic value is still quite healthy and in excess of where we report So with those comments, I'll turn it over to Mark on Slide 6 to take us forward.

Speaker 3

Thanks, Chris, and hi, everybody. Slide 6 looks at our loan production. As we had mentioned, we have strategically decided to Pulled back a little bit on loan production towards the end of Q4 and also beginning of Q1 this year as a result of We saw some of the volatility that we saw in the markets at that time and we've since then begun to pick up our originations and we'll continue to do that going forward this year. Our loan production during Q1 was $217,000,000 in UPB. I think a key takeaway there is of that 2 $17,000,000 in new originations.

Speaker 3

The weighted average coupon on those new originations was 11.1%. So we have continuously during the second half of last year and into the Q1 of this year continued raising our note rates on our loans kind of in response to all the Fed rates last pipeline activity from our borrowers and again 11% weighted average WACC 1st quarter originations this year. If you compare that to the Q1 of last year Our originations, those went off at a whack of 6.3 percent to give you kind of an idea of the strong increase in the coupon that we've put out in our portfolio. On Page 7, what's that done for the overall portfolio? The overall portfolio at the end of Q1 ended up about $3,600,000,000 in UPB, That's a 25% year over year growth from the end of Q1 of 'twenty two and that growth was driven pretty evenly by Strong demand of Investor 1 to 4 and multifamily properties.

Speaker 3

The weighted average coupon of the entire Portfolio at the end of Q1 was 8.15 percent as compared to 7.95% as of the end of the year and compared to 7 point 5.0 at the end of Q1 last year, so year over year. Year over year total portfolio weighted average coupon growth of about 65 basis points That reflects the strong increases we've been doing towards the second half of twenty twenty two and Q1 of twenty twenty three on our note rates. We mentioned last quarter that beginning October 1, 2022, we had elected fair value option, we call FBO, fair value option Counting for our new loan originations, it means we put in those originations on our books now at fair value. So our Q4 originations went on fair value as well as now as our Q1 2023 originations. So at the end of Q1, we now have about $437,000,000 in UPB of loans in our health investment portfolio that are fair value option loans are on the books of fair value.

Speaker 3

On Page 8, our 1st quarter non performing loan asset resolution activity It was strong. Again, we had mentioned during Q4, the NPL resolution activity was down a little, not the rate of resolution. We were still at like a 3% gain, Just the total UPB of resolutions were down and we mentioned that Q4 was just kind of a lower response month and we thought we would See that pick up again in Q1 and we have. We take a look at our Q1 of 'twenty three NPL resolutions, almost $39,000,000 And NPL resolutions for a $1,300,000 gain or a 3.5% gain. And again, if you look at Q4, dollars 25,000,000 in NPL resolutions, but if you look at Q1 'twenty two year over year, dollars 37,000,000 So you see Q1 of this year kind of back to our historical trend in terms of UPB resolve and the type of gains that we're used to seeing.

Speaker 3

So that's very good news. With all that done to our net interest margin on Page 9, as Chris mentioned, our portfolio yield increased 49 basis points The end of the year to end of the Q1, the 49 basis point increase is a combination of the increase in the WACCs, increasing our note rates, As well as those NPL resolution dollars, those gains coming in stronger in Q1. It all goes into your yield, so that drove up the yield. The cost of funds yield increased 10 bps. So again, our portfolio yield well outpaced the cost of funds, but we See a widening out of that.

Speaker 3

We saw some compression in Q4 because of the volatility and now we're seeing that widen back out again. So we ended the quarter with a 3.23% yield, NIM, sorry, NIM. On Page 10, for our investment portfolio performance, we ended Q1 with our nonperforming rate at 8.7%, Pretty much equal or consistent with year ended 8.3%, 8.3%, 8.7%. It's down a full 100 basis points from where it was at the end of Q1 2022, which was at 9.8%. So again, we're seeing that nonperforming loan rates stay fairly consistent.

Speaker 3

And as the previous slide showed, we're still on our historical average of 3 points or more of gain on those NPL resolutions. Our CECL loan loss reserve ended the quarter at $5,000,000 which is basically flat So it was at the end of the year for 2022 at $4,900,000 So we're at 16 basis points. We've kind of been holding a constant 15, 16 basis point where on that level for the past 5, 6 quarters. We don't really see that changing too much right now. And on the CECL reserve, keep in mind that the debt is on the portfolio that is at amortized cost.

Speaker 3

So the newer loans that we put on in Q4 last year In Q1 this year that are the fair value option loans, they are not subject to a CECL loan loss reserve because they're always carried at fair value. So the fair value is kind of reflect if they need to be written up or down. So this reserve is for the older portfolio that's at amortized costs. So As we put on more and more loans at fair value and the amortized cost loans pay down, you'd expect to see that SUS reserve in terms of dollars Hopefully start to come down as that portfolio gets smaller and smaller. In terms of charge offs in the bottom right section on Page 11, we had $484,000 in charge offs in Q1 that was compared to $1,000 in charge offs in Q1, that was compared to 0 in Q2.

Speaker 3

And charge offs is kind of it comes and goes. You can look at the last five quarters, our average charge offs have been about 29 basis points. So very, very low in charge offs. And the one I'd point out on the charge offs is Charge offs is the GAAP terminology for what happens when the loan goes away. And the majority of charge offs sometime come on when you're converting a loan to an REO.

Speaker 3

You charge off the loan. And then keep in mind, when we have that REO, we don't usually fix up the property or work on the property and then we sell the REO And if you go back to the resolution table, the NPL resolution table that we previously showed you, in many cases, we make gains on those sale of REOs. So a lot of times we're recovering those charge offs, but in accounting you don't show there's a credit to the charge offs, it's a whole separate gain on REO, which was reflected in the resolution table. And on Page 12, Durable Funding and Liquidity Strategy. Our cash reserves at the end of the Q1 and unfinanced collateral is very strong at about $45,000,000 $39,000,000 of that was actual cash and cash equivalents, about another $6,000,000 in unfinanced collateral.

Speaker 3

Our Total maximum capacity on our warehouse lines, dollars 832,000,000 is the maximum. At the end of Q1, we still had $533,000,000 of available capacity, so plenty of available capacity for financing, strong cash reserve and available liquidity. Chris already mentioned, we did the securitization of 23 in January and saw improved execution on that as 1 we did in Q4 in October showing the markets coming back a little bit and the indicative pricing that we're seeing now for securitization out in the market right now Shows even a little bit better pricing. And the main other takeaway, as Chris mentioned, and we can't stress enough is that in April of this year, we did that re REMIC, where we received about $65,000,000 in financing by taking retained certificates or tranches from older that we had not issued, we decided to retain them at the time and we re leveraged those in a new security and new non mark to market security And generated almost $65,000,000 in financing. We could have repoed those at any time.

Speaker 3

As Chris mentioned, we do the repo, that's mark to market, that's subject to margin calls. If something happens, this is a non mark to market facility, an older retained tranches. That's a new financing vehicle for us, a new non mark to market financing. And I think that just shows kind of the adaptability that we have in a non mark to market world. I'm very proud of that.

Speaker 3

With that, Chris, I'll turn it back to you to give kind of an Outlook on Velocity's 2023 key business drivers.

Speaker 2

Great. Thank you, Mark. Appreciate it. In terms of the market, Certainly seeing the pressures from higher rates and lower transactions, as I mentioned, but still functioning markets and we're able to liquidate assets when we do end up with REOs. So that seems to be stable there.

Speaker 2

Obviously, there are a lot of crosscurrents in the market and we'll see how things go. From a credit perspective, We're being more cautious and choosy with our lending and I think that's paying off and we'll continue to monitor on By market basis, some of these markets are seeing prices come down, other markets are actually still seeing gains. So we're monitoring Geographic location in the portfolio. In terms of capital, I mentioned the successful transactions that we had and that really put us that creates a lot of capital going forward for us to be in a good strong liquidity position. And then in terms of earnings, we're just going to continue to stick to our knitting and originate assets with good healthy spreads

Operator

The first question comes from Steve DeLaney from JMP Securities. Please go ahead. Sorry about that. The next question comes from Stephen Laws of Raymond James. Please go ahead.

Speaker 4

Hi, good afternoon, Chris and Mark. First, I want to start, very solid numbers, really want to applaud When I look at the UPB recoveries or non accrual rates, things are really holding in there in a volatile environment where We're not few companies can say that about their portfolios. And so looking at that and as the Action you're able to take to free up the liquidity with the Rheuremic. How do you think about opportunities today? I know the WACC was 11.1.

Speaker 4

Can that be increased additionally in this environment when banks and others have pulled back? And how do you think about returns on new money you're putting to work today?

Speaker 2

Sure. Good questions. Yes, I think we feel like we're where we want to be in terms of Spread, could we go higher probably, but if there is an upper limit where you start to get into private money funds That would be competitive with us. So if you look at the current spread and where we're executing On our last two securitizations, we're seeing ROEs well north of 25 And so we think that's a very healthy level and NIMs are 4% or more. We think that's where we want to be and hits our target.

Speaker 2

So I don't think we'll probably raise Much more from here. I mean, obviously, we're going to have to monitor the treasury market and we'll see, but.

Speaker 4

Sure. And I do agree with your point though, like the less competitive environment, that's why you'd be more selective as well on the credit side. And From a growth outlook or maybe originations over the balance of the year, you mentioned you purposely pulled back some in Q1. Kind of how should we think about a monthly or

Speaker 2

Yes, I think the good I think $250,000,000 is a good number going forward. I think we'll see a Slow steady climb this year, barring any craziness, but I think $250,000,000 is a good number for you to use and for us to offer out.

Speaker 4

Great. And then lastly, on the financing side, If I understand it correctly, the REMICs were some security issue that you had retained that you were able to put into a new deal, I assume out of more recent deals. Can you talk about some of the legacy transactions that may be amortized down sequentially and get more expensive? Any opportunities there to call those or look to do some type of re

Speaker 2

So there are 2 more deals left where we could do that, a 2016 deal that is sequential, that's pretty It's very small balance. I think it's under $30,000,000 And then we also have our mixed collateral deal. It was really A deal that financed a bunch of non performing assets. We've got a big chunk of capital there Once that pays off, but it's probably got another 12 to 18 months before that pays off. So that will free up some Future capital, those notes are not callable, so we need to get a full pay down there before we can access that capital.

Speaker 4

Got it. Great. Appreciate the comments this evening.

Speaker 2

Thank you, Stephen.

Operator

The next question comes from Steve Delaney of JMP Securities.

Speaker 5

Hello, everyone. I apologize for I don't know whether it's this market or it's just old age kicking in, but I managed to get time my way back. You're stuck with me.

Speaker 2

I thought you got thrown off your horse. No, that could have been, but it's hard

Speaker 5

to take a call with a cell phone on a horse, I have done that before. Seriously, great presentation to kick this off. Obviously, unfortunate what we're going through. It's hard to believe that at this day and time, we have Major Financial Institutions with Asset Liability Management failures, but It's the crazy world. These the borrowers you're talking to, does it go beyond The 3 brand name companies that have failed at this point, are you seeing it kind of broadly across the country?

Speaker 2

Yes. The short answer there is yes. Definitely seeing most banks, if not all, pulling

Speaker 5

And specifically on real estate, you think?

Speaker 2

Yes.

Speaker 5

Okay.

Speaker 2

Yes. And we're seeing a higher quality of borrowing than we're used to Coming to us that, quite frankly, 6, 9 months ago definitely would have probably ended up at the bank.

Speaker 5

Yes. That's don't wish anything we need financial system stability. So we're not going to root for Problems anywhere else, because that comes back to harness, right, also pay the price, but it is a competitive world and It sounds like the little guy is going to have some better opportunities, it would appear. We're seeing it on The bridge, the commercial mortgage REIT bridge lenders too. On the calls this week, they were all talking about Lots of demand, very the competition is not among the banks anyway is not what it was Even 2 months a month or 2 ago.

Speaker 5

So we'll be interested to see that going forward. Let's think about You've got an 11.1 percent WACC on your new originations. If the Fed the Fed is sort of trying to tell us they're done and whatever let's just say we have lower rates In 2024. And that could be what, I mean, at the long end, it could be 100 maybe Or maybe a little more dependent on the tone of the economy. I mean, what I'm sensing About where you are is your opportunity between the banks and the potential for rate Your opportunity set is only going to grow.

Speaker 5

And I'm just curious, like I think there's a one of the kind of charming things about Velocity is it's not so big and ugly that it's You really can manage your business, right? And you're not just giving up quality to get big. But it Strikes me that there is like over the next 2 years, there is a growth aspect to where you sit today.

Speaker 2

Yes. No, I think that's right, Steve. We appreciate it. It's we've been doing this 19 years, so we've seen all And I think we kind of took our medicine last year when rates were rising So fast, a lot of the banks, their deposits lag and so I think they had to face the music later than we did. So yes, we feel like we have put ourselves in a good position to really grow from here selectively And thoughtfully, but definitely see an opportunity here and it's showing up in the inquiries in Demand aside, we get a lot of requests for financing.

Speaker 2

So you're right, I think if rates were to tick down, that would only probably help us

Speaker 5

Well, congrats on a great start to 2023 and we'll look forward to doing this again in a few months.

Speaker 2

Great. Thank you, Steve.

Speaker 5

Nice job. Thank you.

Operator

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

Speaker 2

No further remarks. Thank you all for joining, and we'll be in touch next quarter. So thank you.

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Earnings Conference Call
Optical Cable Q1 2023
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