Velocity Financial Inc (VEL) 2022 Q1 法說會逐字稿

Good day, and welcome to the Velocity Financial, Inc. first-quarter 2022 conference call. (Operator Instructions)

I would now like to turn the conference over to Chris Oltmann, Treasurer. Please go ahead.

Thanks, Kate. Hello, everyone. And thank you for joining us today for the discussion of Velocity Financial's first-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 first-quarter 2022 press release and the accompanying presentation, which are available now on our Investor Relations website. I would 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 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 appreciate everyone joining the call today. Our team is very proud to report another record quarter for Velocity. During Q1, the Federal Reserve quickly changed the expected course for monetary accommodation, and we saw a very rapid increase in short-term rates as well as fixed income and equity market volatility.

New-issue securitization markets remained open but traded at wider spreads on top of increased base rates. This type of market often reveals the winners and losers as firms navigate difficult conditions, and we're pleased to report strong results despite these challenges. Our unique model, nimble process, and sound risk management enabled us to navigate a tricky market backdrop.

During the quarter, we quickly raised rates for new applications, sold some whole loans at attractive prices and successfully adapted to these new conditions. Our management team deserves credit for rapidly adjusting while maintaining our important customer relationships. In terms of loan production, we had our best quarter ever and generated a volume increase of approximately 150% in new originations over the prior year's quarter.

The tremendous year-over-year growth in our portfolio led to a 43% increase in portfolio-related net interest income versus Q1 2021, which in turn drove an impressive 14% ROE on a core earnings basis for the quarter. It's important to remember that most of our income is generated from our NIM and the earnings from newly created loans occurs over several years and not solely in the month of origination like many other lenders. As it relates to credit, our delinquency rate continues to decline and is much closer to a normalized range as we work off the delinquency impact from the pandemic.

Loan resolutions remain very healthy. And although the real estate market is quite strong, we're expecting the rate of appreciation to slow as rates rise. While this may create some short-term pain, what the Fed is doing is right and should be viewed as a healthy long-term development, in our opinion. Lenders have been rational and extending credit over the last several years, and we see solid fundamentals underpinning the properties we lend on.

Our outlook remains cautiously optimistic, and we continue to see strong demand from our customers despite the higher rate dynamic. We believe our business is built to provide durable and stable earnings as we move forward in all types of market environments.

That concludes our prepared remarks. And with that, we'll turn over to the presentation materials to walk you through that.

Turning to page 3 in the presentation materials. We highlighted in the press release net income of $3 million on a core basis, $0.36 a share. The adjustment there is due to the refinancing costs associated with our new corporate debt that occurred during the quarter. Core EPS growth of 23% from the prior quarter, so very strong growth in the core EPS number there.

I mentioned the increased portfolio driving higher net interest income, 10.9% increase over the prior quarter. And our NIM was very stable versus the prior quarter.

In terms of production, $581 million of new loans in the quarter; 16.8% increase, sequentially. Importantly, we've told folks in the past that we're not as sensitive to rates. And you can see on the sub-bullet there that we increased our WAC on new applications in the month of April to 8.1%, which is pretty close to our historical weighted average coupon that's kind of in the low 8% range over the last 10 to 12 years.

And in terms of applications, we saw $338 million in applications. And that's right in line with the average level of applications that we've seen year to date. So really no impact on volume as we took rates up.

In terms of the portfolio, you see we're up to $2.8 billion now and very pleased with the amount of growth that we've seen. In terms of non-performing loans, I mentioned that on my remarks, we're down to 9.8% as of the end of the first quarter. And very importantly, in terms of our resolutions, we saw another strong quarter of 104.8% compared to the 104% we saw on the fourth quarter. So still seeing very good recovery rates.

I did touch briefly on the refinance of the corporate debt. We previously announced that in a press release. It's a really good transaction for us. We were able to lower our coupon by around 200 basis points and, most importantly, fix that date -- debt for five years. So we took some of that floating-rate risk off.

In terms of the securitization markets, we did complete two deals: one in the first quarter and the second one just here in early April. As I mentioned, those markets were challenged. Both of these deals were not -- did not execute as well as we normally do. We still think there'll be positive earnings and returns there, just not as strong in terms of margin.

But when you blend it in overall with all of the other debt, we think it would just have a small impact on our overall borrowing cost. And we're very pleased that investors continue to participate and support our program. And we think that speaks to the longevity and the history that we've had there.

Turning to page 4. In terms of core net income, we break out the costs here associated with the refinance of that corporate debt. And you can see on a core basis, $12.4 million of income for the quarter, so very strong. In terms of book value, up slightly from $10.84 to $10.90. Most of those non-core expenses offset the gains from just the regular portfolio earnings and about $0.10 a share from the whole loan sales.

So overall, we're really pleased with the way the business is trending and the growth that we've seen and very positive on our core income earnings. So with that, I will turn it over to Mark to take you through the rest of the presentation.

Thanks, Chris. And thank you, everybody, for participating on today's call. The next several financial slides I'm going to go through is going the highlight the strong first quarter that we had, and we really just picked up off of Q4. We had a very strong Q4, and we've built on that so far going forward in Q1, as Chris said. Even with some volatile rate -- interest rate environments, we've really held steady and maintained the business model that we know has worked for us very, very well over all the years.

On slide 5, loan production. Chris mentioned, we've talked about having a record quarter in Q4 originations, and we broke that record in Q1. So we have $581 million in originations, up 16.8% from the prior record of Q4. So we still continue to see strong borrower demand for our product. And the increases came in both the commercial -- traditional commercial as well as the investor 1-4. So we saw increases in the quarter in both of the product types on the origination side.

As Chris mentioned, we also increased our WAC because of the interest rate environment. That's a little bit over 8% and still sold over $300 million of new applications coming in in April. And that's pretty much what we average on a monthly basis, like $320 million, $330 million in the first quarter. So we didn't see any slack off in the April applications as a result of raising the interest rates.

On slide 6, page 6, loan portfolio. Because majority of our loans go to our in-place portfolio as our originations and originated volume would increase, then our portfolio is going to go up accordingly. So the strong originations in Q1 drove portfolio growth. You would see at $2.9 billion was our total loan portfolio at the end of the first quarter, a little over 11% increase when we were at year end.

At the same time, our LTV remains very, very low. If you look more towards the bottom of that page, our average loan -- LTV balance is 67.9% compared to 67.7% for Q4. So we're adding a lot of additional loans, at the same time, holding that loan-to-value ratio consistent at 67%.

Our weighted average coupon on the portfolio was 7.5%, March 31, down a little bit from the 7.76% at quarter end. And again, that's because we had lowered our rates towards the end of last year. Because we were getting much cheaper financing through the securitization market in 2021. So we passed some of that savings on to our borrowers with lower rates as long as we maintain that consistent spread.

And then as Chris mentioned, as we see the interest rates starting to go back up again, starting at the end of March and into April, we've raised our coupons to kind of offset any increase that might come in on the securitization market to, again, maintain that spread. And we've seen the consistent volumes still coming in the door.

On the next slide, our held for investment portfolio. We going to show you this because it will show the minimal interest-rate risk that we have. The rising interest rate environment -- just wanted to show that our HFI, our loan portfolio, as you can see at the end of the quarter, of 70% of our loan portfolio is fully fixed-rate loans. So really there is no any interest-rate risk to it.

The other, roughly say, 30% are hybrid ARMs. Those are loans that they usually have an initial fixed period, three to five years, and then they convert to floating. And as of quarter end, about 70% of those ARMs were in their floating-rate period. But the key thing to remember there, the way our hybrid ARMs are structured, is there's a floor set to the initial fixed rate.

And then when the loans float, they can only float above that initial fixed floor; they can never float below it. So you can only have -- if you lock in a fixed-rate spread at the time they're fixed with fixed-rate securitizations, then you can only have a widening of the spread when the loans float up and not ever below the fixed rate.

On the financing side for that HFI portfolio, you can see about 83% of that HFI portfolio in $2.8 billion, is financed with fully fixed-rate securitizations and then about another 17% is on our warehouse lines. The warehouse lines are floating rate. They're using LIBOR-based warehouse lines.

But remember, those are only -- loans are only on there for about two to three months until we get the aggregation up to enough to securitize. That's very short-term financing. And then they go into the 83% bucket with the fixed-rate securitization. So really a locked-in fixed-rate spread. A big majority of the loan portfolio as well as the financing creates a minimal interest-rate risk environment for us.

On the next page, take a look at net interest margin. Net interest margin for Q1, again, Chris mentioned very consistent with Q4, 4.25% versus 4.27%. Our portfolio weighted loan yield at the end, we said it was 7.76% compared to 8.21%.

And also the debt cost -- the debt cost, says that in the first quarter was 4%, a decrease of 58 basis points quarter over quarter from Q4 to Q1. So if you look at the right-hand side, you can see maintaining that spread. So as the debt cost came down, we did lower the WAC to kind of pass it on to the borrowers. But all the same time, you can see maintaining that spread.

The next slide, loan investment portfolio performance. As we continue to grow our portfolio and grow the originations, at the same time, we're also resolving successfully the non-performing loans. We ended the quarter with our NPL rate at 9.8%. It's not on this chart, but if you recall, at the end of 2020 or in the heat of COVID, that NPL rate was as high as 17%.

And we said at that time, we're not that concerned about it. We've got a very good special servicing group. We resolved these NPL loans very successfully. And you can see from December of 2020 now to end of the first quarter, we're down to 9.8%, back in line with our normal run rate between, say, like 7% to 9%. So we're right within our normal run rate. So very good job in resolving these loans.

And slide 10, as we're resolving these loans, we continue to make gains. I may have to [key in] important part. We're not bringing them -- the NPL rate down through losses. We're continuing to make gains for the first quarter. We've recovered 104.8%, so a 4.8% gain, over and above recovering all the contractual principal and [interesting] to us. And again, that's due, in many cases, to a default interest that we charge, extra 4%, as well as if the loans are resolved by paying off those prepayment fees, too.

So total NPL resolutions in the quarter totaled a little over $37 million. And we had net gains in Q1 of $1.8 million, which is at 4.8%. So we're not only resolving our non-performing loans very quickly and very successfully, we're continuing to do it at about a 4% profit margin on a regular running basis.

For our loan loss reserve or CECL reserve. CECL reserve increased slightly, went from $4.3 million at the end of the year to $4.7 million at the end of Q1; that's mainly because of the portfolio growth. Every single loan you have on your book, have to have some type of loan loss reserve associated with this. As your loan portfolio grows, you're going to have some increase in reserve. So that's expected.

Charge-offs in Q1 were $328,000, but again right in line. We show a five-quarter charge-off there. And our average over, say, five quarters is about $323,000 on a quarterly basis, and in Q1 was $323,000. So it's right in line with the average, and that's kind of what our normal run rate is.

In terms of our financing, and we've talked about this, we have very durable funding and liquidity strategy. As Chris mentioned, the markets are always there for us. We've been there since we started in 2011. We've got a great brand reputation out there. So we've done two securitizations already this year. We did one in Q1, and then we also did another one in April of this year for $253 million. So we've done two securitizations already this year.

And we also refinanced our corporate debt; Chris kind of touched on that. We paid off the previous debt that we had, which was originally $175 million. It was down to $170 million because it would have -- it was amortizing. But that was a floating-rate debt -- a five-year floating-rate debt. And it was about two-point extra coupon -- actually, 2.25 effective yield, was higher, because it was issued at a three-point discount.

So we also had discount amortization on top of the interest rates all hitting the P&L. So we were able to refinance it in Q1 and upsized. It upsized by about $45 million and a 7 and an 8 fixed-rate interest for five years, and it was issued at par. So we don't have the discount amortization as well.

So all in all, in terms of P&L, we're picking up about 2.25% on a go-forward basis over the next five years with no interest-rate risk anymore since it's fully fixed rate. So we thought that was a great deal. And in hindsight, seeing where rates are going now, we locked that in at that rate earlier in the first quarter.

With that, Chris, I'll turn it over to you to go over the economic value of equity.

Great. Thanks, Mark. Appreciate that. On slide 13, we present our economic value of equity. We've done that for a few quarters now. So I won't take everyone through it but suffice it to say pretty similar to what we saw last time.

And just to remind everyone, we don't carry our assets and liabilities at fair value. So trying to approximate, if we were to do something like that and certainly in terms of the embedded gains, there could be a much higher mark in terms of book value. So again, I still think that we're -- we've got a lot of untapped value that's yet to be realized.

On 14, just looking at the outlook. We still see very strong demand in our niche. Things are going well there. Obviously, there are a lot of macroeconomic and geopolitical uncertainties. So that does make everybody, I think, be a little bit cautious, but we're continuing to lend at levels that we always have. And we're hoping for the best, preparing for the worst at the LTVs that we lend up. We feel very confident even if things get rough, we'll be in good shape.

In terms of capital, the new debt transaction obviously gave us some additional growth capital. So it was great for us and continue to believe that we'll be able to securitize and access the capital markets as we have throughout the year. So that, we believe, will just continue to fuel our growth.

And then from an earnings perspective, we continue to recognize good operating leverage as we grow the portfolio faster than expenses and definitely think that we'll be able to achieve our targets for NIM and a very stable, durable type of earnings going forward.

So that summarizes our prepared remarks and our presentation. And I think we should open it up for questions.

(Operator Instructions) Steve Delaney, JMP Securities.

Thanks. Appreciate the question. I can't tell you how refreshing it is to be on a residential earnings call this week for somebody who doesn't use gain-on-sale accounting and fair value of its residuals. [I'm saying] there's a lot of pain out there, and I'm sure you've heard some of those calls. So props on that. It makes a lot of sense for you.

Just a little clarification on page 17. You mentioned $0.10, Chris, for whole loan sales. And it looks like to me, from page 17, I get more like $0.13, not that it really matters. But Mark, can you help clarify that? I'm seeing $4.5 million in gains on 34.2 million shares.

I don't -- Chris' number might have been tax [effect, too] -- by the tax effect as well. I mean the $4.5 million is not tax effect, right? That's not all going to net (multiple speakers).

I got you. Yeah. Okay, my bad. I apologize for that. Yes, I keep forgetting you're not a REIT. You got to pay taxes. Okay. Got it.

Yeah. Yeah. We're a C-corp, yeah.

Okay. And Chris, it's obvious that -- you mentioned that the securitizations, they didn't execute as well. Obviously, your blended NIM is still up at 4.25%. What primarily needs to happen -- I mean, I know time, volatility just kind of blows everything out.

But for the markets to recalibrate, how much of that is going to be on you guys to get your coupons up above 8% and still find some loans to make? I mean is it a combination of higher coupons and hoping the investors, if things will settle down and credit spreads, will come in a bit?

Yeah. Yeah, I think that's right. I think it's a combo of the two. As I mentioned, historically, we've been -- we've lent in the, call it, 8.25% to 8.5% range. So we're, in our mind, getting back to where we've always been. So it doesn't feel extraordinary for us.

We were oversubscribed in both of the securitizations, and so we saw a good demand there. And just in talking to market participants, their big struggle is really just where is the Fed going to go and what's the right level to put money to work at.

So I think, fortunately, because we are out in the market frequently, it blends. We can -- sometimes we can get amazing execution; sometimes we get poor execution. But most of the time, we get what we expect. And so I think as we get more certainty and clarity from the Fed and inflation, where rates are going, we'll see more investors on the fixed income side putting money to work.

Yes. Makes sense. And if you step away from the market, you're not sure your investors will be there when you decide to come back. So I hear you loud and clear. Thanks for the comment. I'm sure the other guys have some things to ask, too. So I will leave it there.

Thank you, Steve.

(Operator Instructions) There are no other questions at this time. This concludes our question-and-answer session. I would like to turn the conference back over to Chris Farrar for closing remarks.

Thank you so much. I'm excited to present our quarterly results. Our calls tend to be very simple because we have a very simple business. And we try to keep it that way. So I appreciate everyone's support, and we'll talk to everybody next quarter. Thanks so much.

Thank you, everybody, for participation. Have a nice day.

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