Velocity Financial, Inc. (VEL) Q2 2022 Earnings Report, Transcript and Summary

Good day, and welcome to the Velocity Financial Inc. Second Quarter 2022 Conference Earnings Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] 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.

Thanks, Andrew. Hello, everyone, and thank you for joining us today for the discussion of Velocity Financial's second quarter 2022 results. Joining me today are Chris Farrar, Velocity's President and Chief Executive Officer; and Mark Szczepaniak, Velocity's Chief Financial Officer. Earlier this afternoon, we released our second quarter 2022 press release and the accompanying presentation, which are available now 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 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. 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. And with that, I will now turn the call over to Chris Farrar.

Thanks, Chris, and welcome everybody to our second quarter earnings call. Before we dive in, I want to recognize our CFO, Mark Szczepaniak, recent award from the Los Angeles Times as CFO of the year. Anyone who's worked with Mark knows he's a true leader and a genuinely great person, his commitment and work ethic permeates our culture and we're very fortunate to have Mark on our team. So congratulations, Mark, on a well-deserved award. In terms of our results, we reported another outstanding quarter in an obviously uncertain time. Our unique portfolio approach continues to generate stable earnings with limited volatility. Originations moderated this quarter as our recent coupons increased to the mid-8% range. And fortunately, we're continuing to see healthy loan submissions at those levels. We're currently in the market with our fifth securitization of the year, and we're pleased with the strong support we've seen from our investor base. For seasoned loans, our delinquency continues to normalize and our special servicing team consistently delivers impressive results. We're beginning to see a cool down in the real estate market, which we think is healthy, and there are still plenty of loan opportunities for us to invest in. Due to the recent market volatility, we're also being shown some interesting opportunities to acquire good assets from distressed operators. We intend to capitalize on those situations as they develop in the second half of this year. From a liquidity perspective, we're in the strongest position we've had in many years. Due to our stable portfolio earnings, we can be patient in deploying our capital and will manage our liquidity carefully as the market evolves over the next six to 12 months. Despite the recent headwinds, we are very confident in our ability to grow and deliver strong returns for our shareholders. With that, I'll turn over to the presentation materials, starting on page 3. Looking at the second quarter from an earnings perspective, nice strong earnings, $10.6 million, both on a core and GAAP basis, healthy increase year-over-year. Down a touch from the first quarter on a core basis, and that's mainly driven by fewer loan sales. We made more loan sales in the first quarter and the second quarter, decided to securitize more assets. And as we've said over time, we'll be opportunistic when we make those sales. From a net interest income perspective, up almost 25% year-over-year. So very good strong net interest income growth as the portfolio grew and an exceptional quarter from the NPL recovery rate of 111% over above accrued interest and outstanding UPB. We saw some really nice pickups there from some older seasoned loans that had been unresolved for a long time and a couple of REO gains. So just great performance there. In terms of production, you can see year-over-year, about 74%. So very nice growth on a quarterly basis. And then for the first six months of the year, over $1 billion, which is more than twice the amount that we had done in the prior year. So fantastic growth across the platform. We ended the quarter with $3.1 billion in terms of UPB. And as we've come out of COVID and started to see borrowers get back on their feet, we've seen the nonperforming rate reduced dramatically as borrowers care and NPLs get resolved. From a financing and capital perspective, we completed three securitizations during the quarter. I think that speaks to our strength out there in the track record and the history that we've had of bringing good deals to market. And so we're proud to be able to continue to execute in choppy times. One of those transactions was a refinance of a deal that we've done during the heart of COVID, and we had a tremendous amount of capital tied up in that transaction. So that freed up a lot of liquidity for us. And probably, in my mind, one of the most important highlights of the quarter is we're sitting at $134 million in at the end of the quarter, which really puts us in a good position to not only take advantage of interesting opportunities, but also just patiently watch and see how markets develop. Lastly here, we did increase warehouse capacity, another $100 million during the quarter. And as a reminder, all but one of those facilities is non-mark-to-market. So we've eliminated that risk almost entirely across the portfolio with securitization and non-mark-to-market facilities. Turning to Page 4. You can see book value per share $11.26. I think this year -- sorry, this slide just highlights our unique portfolio approach of building book value and trying to maximize shareholder return with limited volatility. So number of our peers are seeing big marks just based on market volatility and our sort of approach and accounting methods, I think, eliminate a lot of that. So I'm proud of how the business has performed. And with that, I'll turn it over to Mark to handle the rest.

Thanks, Chris. Good afternoon, good evening, everyone, and thank you, Chris, for the kind words. Of course, I had to pay him enough to say all those things, but that's a different story. On Slide 5, for loan production. As Chris mentioned, we have very strong loan production for the first half of this year, a little over $1 billion compared to about $489 million for the six months of 2021, which is a 110% increase in production. We only had $1.3 billion fundings for all 12 months last year. So, we're at $1 billion for six months, we're still seeing very strong demand for our product. We have $445 million funded in Q2. As we've seen a little bit we've been raising our WACs on our loans, our new loan applications to kind of keep up with the interest rates that we're seeing on the finance side to maintain that spread. You see that in just a moment. So, even after raising our WACs and actually our Q2 production, new originations on Q2, our weighted average coupons were up 145 basis points from the new originations that we had in Q1. So, we've been aggressively raising the rates and still seeing good, strong production coming in, in Q2 and again in the first six months of the year. So, very happy to see that. On slide six, the production comes in strong, the loan portfolio is growing accordingly. We're putting most of that into our portfolio, our in-place portfolio with our lot spread. Our total loan portfolio at the end of June was $3.1 billion, that's up 7% from $2.9 billion as of the end of Q1 and up 49% year-over-year compared to June of last year. Again, just showing the very, very strong demand for our product. And the weighted average coupon was 7.53%, and that's up from 7.50% for the first quarter. So, again, we're raising the rates, getting the coupon up to offset the rising interest rates on the financing side and still getting in the volume and able to grow the portfolio significantly. On slide , the net interest margin, what we're seeing is more of a return to normalized levels in our NIM. If you go back to second quarter of last year, you can see on the page, it was up at $483 million. And we had said in some previous calls, that, debt margin was kind of inflated. We're getting higher margins because we're getting a lot of the default interest, prepayment penalties as we were bringing the NPL rate consistently down. So, that yield coming through was not a sustainable yield over the long haul and we normally run like around four point margin. And you see we're normalizing back to kind of our normal run rate margins. We feel really good about that. And as our non-performing loans are resolved, the default interest in prepayment fees have kind of started to normalize because our NPL rate has come significantly down, and we will take a look at that. But while we're doing that, we're still maintaining our spreads. If you look at the right-hand side, the portfolio yield and cost of funds, you can kind of see you go back to Q2 of last year, when interest rates were higher, we were charging more on the loans and of course, our debt costs were a lot higher at 4.81%. And you can see as Q1 came into play as rates came down in the second half of 2021 into the first quarter of 2022, we lowered the WAC on the loans, still maintaining that spread and we've been very aggressive now going into Q2 and through Q2 as interest rates have gone back up on the financing side. Again, as I said, we've increased the WACs almost immediately to keep that yield on our loans still maintaining that spread throughout. On page eight, the asset resolution activity. We continue to see strong resolutions on our NPL resolutions for Q2, $50 million in UPB for a $5.7 million gain, that's an 11-point gain on a resolution. So, historically, we've run around a three and a half, four point gain on our resolutions of NPL loans, and we 11 point gain for Q2. And as Chris mentioned, some of the things in there. In Q2, we did sell a couple large REOs that probably brought in about $1 million gain and then if you look at the resolution activity at the long-term loan side up in the top, you see paid in full for Q2 was up $17 million UPB paid in full for a $3.3 million gain, where for Q2 of last year, so it was $21 million, but even both smaller gain. And the reason that's happening is some of those, as Chris mentioned, some of those loans that were in foreclosure in the judicial states where it takes about 1.5 years to two years to settle those loans. Some of those are not finally coming through. And remember, we've got that four-point default interest tacked on, and that's accruing the whole time it's a network closure process. So as these borrowers are now paying off those loans because we're getting the front we can foreclose on the properties, and they don't want to lose the property. So as they're paying off these loans, they have to pay it off. They have to come up with all that default interest too. And that's why you're seeing a lot of those big kings coming through. And one thing to point out is not on this slide, but with that growth in production, growth in the in-place portfolio and maintaining that spread, we're seeing great core diluted earnings per share. You saw it was $0.31 for Q2. Year-to-date, which was not on the slide, year-to-date, our core diluted EPS of $0.67 a share versus $0.45 a share for the first six months of '21. So year-over-year or six months over six months, we've seen a 50% increase in that core diluted earnings per share. On the next slide, the loan investment portfolio performance. And as I mentioned, with all that strong resolutions that we're doing, the NPL rate continues to come down. We ended Q2 at an 8.2% nonperforming rate year-over-year comparison that compares to 15.3% where we're at Q2 of '21. And remember, at the end of 2020, we were as high as 17.1%. So we feel very, very good about the way we've been able to get these loans performing again or to resolve the loans by having them pay down or pay current, all at the same time still making a four point or even you saw 11 points in Q2 gain on those resolutions. And that's mainly because of our own in-house special servicing department. It allows us to take charge of those nonperforming assets, really work with the borrowers and getting very, very successful resolutions and that kind of in-house strategy really pays off and you can kind of see the results here. In terms of our loan loss reserve or CECL reserve, it remains very consistent in terms of basis points of reserve on UPB. That's in kind of the bottom left-hand chart. You see we were 19 bps back in Q2 of '21. We kind of had additional reserves on there, not knowing that uncertainties of the COVID and now we're kind of evening out right around the 16, 17 basis points. In terms of total dollars, we ended the quarter at $4.9 million, which is a 5.2% increase from Q1 and a 24% increase from June of last year, and that's really as a result of just the growth of the portfolio. As our in-place portfolio grows and you're maintaining a 16, 70 basis point spread, the dollars of the reserves are going to grow accordingly. The key point is, on the right-hand side of the bottom, you see our charge-offs. Our charge-offs has been running consistently low, and that's historical too. If you look at the last four quarters, the average charge-offs -- loan charge-offs have been about $168,000 a quarter with this most recent quarter, it's coming in at under $38,000. So again, strong resolutions, NPL rate coming down, very low charge-offs, very good gain and kind of maintaining our margin in a very kind of widely moving interest rate environment. So we kind of feel very good about our results and where we're headed so far this year. On page 11, a durable funding and liquidity strategy. Chris, I think hit most of the high points there. We did four securitizations already in 2022. I think we did four all last year, and we bring on four during six months. Three of those securitizations were in Q2. So we actually did securitizations April, May and June which again just goes to show the investor demand for the product that's out there. We're having no problem getting the securitizations done, in a pretty kind of widely moving market. So we feel really good about that. We did $896 million worth of securitizations issued this year, of which $623 million almost was in Q2. And we’ve seen a couple of things with these securitizations. One, we're able to collapse a couple of older deals. One deal is as far back as 2015, which was the old sequential structure -- sorry, yes, the sequential structure and that sequential structure, as it pays down, gets more expensive. So that was a higher yield deal. We're able to collapse that and re-securitize it in our pro rata structure and actually at lower cost. And then the old MC1, the mix collateral deal that we did back in July of 2020, kind of, in the heat of COVID to get the securitization and liquidity, was only at a 65% advance rate. So we had a lot of equity and collateral tied up in that deal. And we -- and as it paid down, our equity just went up, because all the payments was a turbo, went right to the bondholders, take them down and our equities kind of kept growing, we were able to deleverage that almost like a 75% advance rate and generate quite a bit of liquidity, as Chris mentioned. So we're able to doing those deals, ending up the second quarter with about $134 million in available liquidity, $46 million of that being the cash that you see on the balance sheet and then another $88 million in loans that are unfinanced, that we can put on lines at any time and draw the liquidity off of. So we feel really good about our liquidity position ending the quarter. And as Chris mentioned, we raised the maximum capacity of our warehouse lending from $650 million to $750 million. So there is $100 million capacity, as we again see the production growing and the portfolio growing. So with that, I'll turn it back to Chris to go over the economic value of equity.

Thanks, Mark. Appreciate it. On slide 12, we've shown this slide a few quarters in a row now, so I won't spend a tremendous amount of time on it. But want to make the point that most of our peers mark their balance sheet to fair value. And if we believe, if we were to do something like that, we'd see a much higher mark than we -- than you see just looking at the face of the financial statements, and that's largely driven by the locked-in spread and embedded gain in the portfolio. So we think from a value perspective, we're undervalued based on where our stock is trading today. And I want to try to highlight that we think there's a lot of future value that's yet to be realized. 13, just kind of talking about the outlook. We mentioned that we are seeing good demand from a credit perspective, we feel very, very safe there. And there's been a lot in the press about what's going to happen and what may happen. But so far, we think things are good and we expect it to continue that way. We do plan to do two more securitizations this year and I think from an earnings perspective, we just want to continue to focus on managing the portfolio, providing that stable spread and looking for any opportunities to grow, both organically and strategically. So with that, we'll turn it back over to Andrew, we can see if there are any questions.

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Arren Cyganovich with Citi. Please, go ahead.

Thank you. On the production side, obviously, a solid quarter, a little bit lower. And it sounds like you were able to pass through some of the increase which -- in price, which slowed down the production. What level of production are you expecting in the second half of the year relative to -- I guess, maybe you talk about how the cadence happened throughout the quarter?

Yes. Hi, Arren, good question. I mean, I think the right guidance is kind of with the second quarter level. We feel good that we're going to be able to deliver that for the next few quarters. So I think that's a good run rate.

Okay. That's good. And then on the securitizations that you did recently, how have those been pricing relative to some of your earlier securitization?

Yes. So they're definitely pricing a lot wider than certainly 2021. 2021 was a banner year for us, and we were getting some incredible pricing there. So -- and I would say, their pricing a little wider than even before 2021. So margins aren't as strong on the most recent deals as probably they have been historically. But I think on a go-forward basis, we feel like we've caught the pipeline up now and I think will be there. Obviously, it depends a lot on where the market goes from here, but we're feeling like we're back-end line from a spread perspective now.

And that would be kind of around that 4% type of NIM? That's the expectation?

Yes. That's right.

Okay. Great. Thanks a lot.

You’re welcome.

[Operator Instructions] The next question comes from Steve DeLaney with JMP Securities. Please go ahead.

Thanks. Hey, guys, congrats on a really strong quarter, and obviously a very challenging market. And Mark, congrats to you from another a former public company CFO. It's a tight stuff work, so great job.

Thank you.

Chris, you talked about the stress situations, seeing some things out there. Boy, we have seen some shops shut down. And just this morning, I saw a mortgage REIT write-off over $20 million of a pref equity investment in an originator who had ceased operations. So we know those kind of things are out there. Just curious, as you look at those opportunities, is it a matter of just looking at loan collateral that may be sitting on warehouse somewhere or is there any interest in infrastructure and any product expansion opportunities? Thanks.

Sure. Thanks, Steve. Appreciate it. Yes. So we've seen both asset opportunities and strategic opportunities, and so nothing huge yet, but I feel like it's the beginning of probably a larger opportunity set. On the asset side, yes, I think, you're largely seeing assets that are probably home either on a warehouse line or maybe have some scratch and dent characteristic or something like that, where we would obviously look to pick those up at a discount. And then I think strategically, we've seen a couple of platforms we've looked at nothing compelling yet. And we haven't seen anything in terms of new products, but we're open to that. And so my gut tells me over the next six months, we may see something like that.

Okay. Yes. Okay. Well, that's -- the last year or so, it's been just a matter of your own -- keeping things straight in your own kitchen, right, but you guys have really gotten yourselves squared away and you've got a strong position to take advantage. Just curious where you're pricing today, I mean, I assume, we're probably up to something near an eight handle and how the demand is looking at that type of a coupon?

Yes. So we're -- the more recent production is kind of 8.5% to 9-ish coupon? And yes. And the -- just in the last few weeks, submissions have been very strong. So I think there's -- what I call kind of the sensitivity period where customers and client borrowers are kind of adjusting to things? And there's like a whole back or a lull, if you will, and then people start to realize this is the new reality and they transact. So -- there was a little bit of an adjustment period there for sure, but very pleased to see how strong submissions have been.

Great. Thank you both for the comments. Appreciate it.

Thank you, Steve.

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

I just want to say thanks again for everybody for participating and all of your support, and we're grateful for the years of support that we've seen from everyone. So that will conclude our call. Thank you.

Thank you.

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