Velocity Financial Q2 2023 Earnings Call Transcript

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August 3, 2023

There are 6 speakers on the call.

Operator

Good afternoon, and welcome to the Velocity Financial Second Quarter 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 Chris Altman, Treasurer.

Operator

Please go ahead.

Speaker 1

Thanks, Danielle. Hello, everyone, and thank you for joining us today for the discussion of Velocity's Q2 2023 results. Joining me today are Chris Farrar, Velocity's President and Chief Executive Officer and Marc Sapaniak, Velocity's Chief Financial Officer. Earlier this afternoon, we released our Q2 2023 results and the press release and accompanying presentation are available on our Investor Relations website. I'd like 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 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 SEC filings. 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. 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 we appreciate everyone joining the call today. We're pleased to report another excellent quarter and thank all of Our continued growth in earnings and book value are a result of a sound strategy and attention to detail Our origination pipeline is very healthy and we continue to be choosy with credit as we've seen increased demand with Thanks tightening their lending activities. This pullback has allowed us to create attractive risk adjusted yields for new portfolio loans. We recognized A 19% increase in originations versus the prior quarter, while holding expenses flat, which obviously improves our operating margins. With respect to credit performance, we continue to profitably resolve delinquent loans and recognize overall gains from recognizing default interest.

Speaker 2

Our delinquency rates increased this quarter and we expect the net resolutions of these assets to continue to drive future gains similar team continues to sell REOs at a healthy pace and the markets are liquid when priced reasonably. Frost has come off Some of the overheated markets as Fed policies cooled the rapid price appreciation we were experiencing, which we view as a long term positive for our business. Capital markets are improving as we see spreads starting to tighten and better investor in the new issue market due to limited supply and the potential of a terminal rate from the Fed. Our financing relationships and capital sources are strong as we continue to grow in earnings per share, great quarter for us. I mentioned the net revenue growth earlier, up 6.8% quarter over quarter with flat Operating expenses, that's a testament to our operating team and doing a great job of growing volume and controlling costs to improve margins.

Speaker 2

Overall portfolio yield increased up 24 bps year over year, which As a result of putting on these new loans at much higher coupons, obviously, we've got a large fixed rate component there, so to move that coupon That much speaks to the volume that we've been doing at these much higher levels. In terms of production, I mentioned $258,000,000 up for the quarter, up from the previous quarter, from last year, but as you can see from the earnings, earnings are not driven by current month or Current quarter production, so we're very comfortable with the levels that we're at right now and we're more focused on allocating capital With attractive art returns as opposed to just doing volume. Portfolio is growing nicely from the net growth of the originations. And in terms of credit performance, the NPLs For the quarter, moved up to 10% from 8.2% in the previous quarter. There are really three things going on there.

Speaker 2

1, The portfolio seasoning, just as a reminder, last year we did $1,700,000,000 in originations and delinquency tends to Peak 24 to 36 months after originating a new loan. So, as the portfolio seasons, we'll see some of that delinquency Come on. 2, we're quick to put borrowers in foreclosure. Many lenders will work with a borrower when they're delinquent or Delayed in making payments. If borrowers will communicate with us, we're often open to doing that and if There's a viable plan to work them out.

Speaker 2

But if not, we're very quick to put someone into foreclosure, especially if they're not communicating with us, just to make sure we get a resolution and we protect the equity that we have ahead of our loan. And then thirdly, The NPLs come on a lot faster than they come off. So if we move quickly to pop them into foreclosure, It might take several months for something to resolve, so there's kind of a lag effect there. Most importantly, we continue to see the Positive gains over and above contractual principal and interest and we continually monitor our portfolio and look at delinquent assets and based on everything We don't expect our results to be any different than what we've historically seen. In terms of financing capital, Had a really nice transaction earlier in the quarter where we did a re REMIC of several of our retained interests from previous deals.

Speaker 2

This was a great transaction for us because it continues down the theme of non mark to market financing where Almost all of our financing now in the book is non mark to market. Investment banks offer us repo facilities on those Securities, but they come with mark to market risk. So we think this is a more elegant solution to control risk and it was a great transaction for And then I guess I would just say in terms of liquidity $72,000,000 so we're in real good shape there with all of our financing counter And have plenty of capital to grow. Turning to Page 4, very straightforward and simple, nice Earnings growth, adding to book value, as we've kind of always said, is our strategy. And you can see, we Ticked up to $12.57 on a GAAP basis, so continuing to just focus on growing Earnings and growing book value.

Speaker 2

On Page 5, we think that we've created a lot And this is a buildup of Not only the inherent value in the platform, but also what we think is created in Future value of the business and a potential premium if someone were to maybe be interested in acquiring the business. So Suffice it to say, we think the economic value of the company is much higher than the book value on a GAAP basis. So with that, I'll turn Over to Mark on Page 6.

Speaker 3

Thanks, Chris. Hi, everybody. Continuing with the financial results on Page 6, We can see the improved loan production as interest rate increases have slowed down. Q2 production was just Under $259,000,000 in UPB, and as Chris mentioned, the 19.2% increase from the $217,000,000 in Q1. The weighted average coupon for both Q1 and Q2 production, so far year to date in 2023, was 11%, and that's about a 3.25% year over year increase over Q2 of 2022 in our weighted average coupon.

Speaker 3

The strong production increase in Q2 at the 11% WACC demonstrates with continued borrower demand for our products. Moving to Page 7, it shows the strong portfolio growth attributable to the improved loan production. Our total loan portfolio as of June 30 was $3,700,000,000 That's a 3.4% increase from Q1 20% increase from Q4 of last year. The weighted average coupon on our overall portfolio as of June 30 was 8.40 percent, That's 25 basis point increase from the portfolio of Q1 and 87 basis point increase year over year from Q2 2022. So We've increased our coupon, our production is growing and all this with the LTV ratio still remaining consistent quarter over quarter at 68%.

Speaker 3

On the next page, our Q2 net interest margin remained consistent with Q1 at about 3.25%. Looking at the components of net interest margin, Our cost of funds increased 25 basis points quarter over quarter, driven by higher utilizations of our warehouse line and cost in the warehouse line. Our portfolio yield on the loan side increased consistent the same increased 25 bps quarter over quarter, driven mainly by the 11% overall weighted average coupon on our year to date 2023 production. Net result in Q2 NIM is consistent with Q1. On Page 9, our non performing loan rate for Q2, as Chris mentioned, increased to 10%, driven by a combination of portfolio seasoning.

Speaker 3

As Chris mentioned, we did $1,700,000,000 last year. We did $1,000,000,000 of that really in the 1st 6 months of last year. And as that portfolio starts to season. We're going to see a little bit more delinquencies and also the strong collection efforts by our special servicing department. During the 1st 6 months of 'twenty two, we funded that $1,000,000,000 Our special servicing department is being more aggressive in collecting the efforts on the NPL loans.

Speaker 3

Of that 10% non performing, as Chris mentioned, we're quick to put borrowers into foreclosure because that's where we get their attention, that's where we get The payoffs and the pay currents that we see on the resolution table, that's when we get the gains. So that 10% over 7.5% of that was foreclosure. Page 10 illustrates the continued success of our NPL resolution efforts. In Q2, we resolved over $50,000,000 in non performing UPB for a net gain of $1,500,000 over and above collecting all the contractual principal interest and again maintaining that 3% or 3 point gain on our NPL resolutions. Moving to Page 11, presents our CECL loan loss reserve.

Speaker 3

The CECL reserves at June 30 was $4,600,000 or 15 bps of our outstanding loans held for investment and amortized cost balance. Our CECL reserve has been very consistent between 15 16 bps over the last 5 quarters. And kind of just as a reminder, the loans carried Fair value that we started doing in Q4 of last year are not subject to a CECL reserve. Q2 charge offs are shown on Page 11, a $717,000 for the quarter, second quarter. However, subsequent to closing the books During our post close internal review process, we discovered that one of our servicers have received funds from a borrower in the amount The actual Q2 charge offs for Q2 were $324,000 not the $717,000 or 39 basis points of non performing loans, not the 87, which is actually a decrease from Q1.

Speaker 3

Management determined that the adjustment was to the overall results of the quarter as opposed to reopening all the books, we will record this $393,000 recovery in Q3. Finally, Page 12 shows our durable funding and liquidity position at the end of Q2. Total liquidity as of June 30, dollars 72,000,000 comprised of $34,000,000 in cash and cash equivalents and another $38,000,000 in available liquidity on our unfinanced loan collateral. Just mentioned, we issued 2 securitizations in Q2 in April. We issued the 2023-1R security.

Speaker 3

That This new type of financing demonstrates the diversification and financing options for our company and is another type of very cost effective non mark to market financing for us. This re REMIC generated about $48,000,000 and cash proceeds to us. And then in May, we issued the second securitization 2023-two, which is one of our long term normal securitizations. We issued $573,000,000 so still plenty of capacity to continue pursuing growth in our production. That wraps up the financials.

Speaker 3

And I'd like to turn the presentation back to Chris for a discussion of Velocity's economic outlook. Chris?

Speaker 2

Thanks, Mark. Looking forward, we think the market is doing very well, especially in light of all of the Fed action, Continue to see very strong real estate market. I think some of the areas that We're overheated, have cooled down, which is good. And in terms of credit performance, we Keeping a close eye on it, but we think that we're going to do very well and continue to see good positive resolutions, In good shape from a capital position and we think we continue to grow earnings and still see strong And for our products, so we expect to grow the portfolio and grow earnings. So, I think all in all, everything looks really good.

Speaker 2

So, With that, we'll open it up for questions.

Operator

The first question comes from Steve DeLaney of JMP Securities. Please go ahead.

Speaker 4

Good afternoon, everyone. Can you hear me?

Speaker 3

Yes. Great.

Speaker 4

Well, I'm ahead to be on my cell, so I apologize for that. Nice quarter again. I think we say that every quarter, hopefully, if not so good.

Speaker 3

Never gets old, Steve. Yes, for sure. Could you speak a

Speaker 4

little bit about 20 three-two and just how that execution went compared to 20 three-one?

Speaker 2

Sure. Yes. So I think I would say it was Pretty similar, not quite as strong demand, as we saw in -one because It was kind of pre the banking crisis. I think things were really starting to tighten up at the beginning of the year and then that obviously put a damper on But we were oversubscribed and able to get very good execution and then We're out in the market actually right now with our next deal for Q3 and we're getting

Speaker 4

Is that factor? Are people looking at that as a positive or are they scared that that's going to lead to credit For credit performance without much carry?

Speaker 2

Yes. I would say it's probably The former, not the latter. I mean, if you look historically over the last 18 years, that coupon is not outside of the band of where we've been. So, I mean, everybody always asks why is that the case and etcetera. But I haven't heard

Speaker 4

And one for Mark, if I may, and then that'll be it for me. Nice book value growth in the quarter. We had a couple of Credit mortgage REITs in the last 24 hours report and they used securitizations and there were declines in book values and Obviously, they mark both sides of their securitizations. I'm sure there were some credit spread impacts in this, but we saw The book value declines that were in the 4% to 5% range quarter over quarter. I was just curious, Mark, if you can comment on I know you have your HFI portfolio and then from for investment and now you have your fair value portfolio.

Speaker 4

Correct. I guess I'm really asking about the fair value portfolio and how that worked out this particular In the Q2 given the increase we've seen in the tenure. Yes.

Speaker 3

And you're exactly right. I mean, The one thing, remember, we did, we started marking our loans, our loan originations to fair value beginning with Q4 last year, October 1 last year. Right. But then starting this year, 1st of 2023, we also elected to mark our securitizations at fair value. So you're right, there was some Decline in the fair valuation of the loans quarter over quarter, but then on the converse side, because remember our securitizations are fixed rate securitizations That exactly equals too much hedge.

Speaker 3

It's a natural hedge on the loan. So when you have a fair value loss on the loans, our natural hedge Just kind of kicking in and we picked up, you'll see fair value gains on the securitization. Look at the financials we put out in the Q, you're going to see good sized fair value gains quarter over quarter on the securitization. That kind of what maintains that growth in book value is that natural hedge for that securitized portfolio.

Speaker 4

Okay. All right. Well, I will leave it there and give someone else a chance for questions. Thanks for your comments.

Speaker 2

Thanks, Steve.

Operator

The next question comes from Stephen Laws of Raymond James. Please go ahead.

Speaker 5

And I know you guys see some tailwinds in the business. And Mark, I really want to start with that. Can you talk about the Competitive landscape or lack thereof from the banks, I know 3 months ago we talked on the call and you talked about being able to improve kind of your underwriting credit Standards on new production and maybe getting some stuff that possibly would have gone to banks previously. Banks pulled back even more, Have they reentered at all? Can you maybe give us an update on those comments versus last quarter?

Speaker 2

Sure. That was directed to Mark or

Speaker 4

I think it was Chris.

Speaker 5

Oh, no. I'm sorry, Chris. That's for you.

Speaker 2

Okay. Got it. Okay. I saw that.

Speaker 5

Sorry, Mark, you Sorry, nice for you, Craig.

Speaker 2

No problem. Yes, I would say the environment feels Pretty similar to where it was in Q1. I don't think it's gotten worse or better, but you're definitely seeing the banks be cautious And we're hearing from borrowers who come to us and say, I can't believe the bank wouldn't do this for me. Can you guys help me out? So I would say the opportunity set seems to be about the same.

Speaker 5

Great. And then as far as your origination volumes, as you look out and apologies if Covered it in the first couple of minutes, so I was a touch late. But it seems like picked up a little in Q2. I know early in Q1, you guys had sort of become cautious, got or active later in the quarter. Do you think you're kind of at your normal run rate here for the second half?

Speaker 5

Do you think things more likely to maybe pick up, go down, kind of how do You know frame volume as we move through the back half of the year and into 'twenty four?

Speaker 2

Yes. I think this is a good run rate. I think we're projecting this out for the rest of the year. And I think we think that we'll end the year right around $1,000,000,000 So I think this feels

Speaker 5

Great. Well, again, nice quarter and appreciate the comments this afternoon.

Speaker 2

Thanks, Stephen.

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

Thanks everybody for joining. We appreciate all your support and look forward to talking to you again next quarter.

Operator

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

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Earnings Conference Call
Velocity Financial Q2 2023
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