Velocity Financial Inc (VEL) 2023 Q2 法說會逐字稿

Good afternoon and welcome to the Velocity Financial second-quarter 2023 conference call. (Operator Instructions) Please note this event is being recorded.

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

Thanks, Danielle. Hello, everyone, and thank you for joining us today for the discussion of Velocity second-quarter 2023 result. 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 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. 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.

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

Thank you, Chris, and we appreciate everyone joining the call today. We're pleased to report another excellent quarter and thank all of our team members who worked so hard to support our mission. Our continued growth in earnings and book value are a result of a sound strategy and attention to detail from everyone at the firm. Our origination pipeline is very healthy, and we continue to be choosy with credit as we've seen increased demand with banks 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 margin.

With respect to credit performance, we continue to profitably resolve delinquent loans and recognize overall gains from recognizing default interest. Our delinquency rates increased this quarter, and we expect the net resolutions of these assets to continue to drive future gains similar to our long-term history as the real estate market remains stable in terms of valuation. Our special servicing team continues to sell REOs at a healthy pace and the markets are liquid when priced reasonably.

Process 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 participation 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 earnings and work to improve our return on equity. In short, our business is performing very well, and the team is passionate about growing our assets, our people, and our opportunities.

As always, we appreciate all shareholders, and we'll work to deliver value every day. I'll turn over the presentation now and walk folks through a couple of slides and then hand it over to Mark.

On page 3 from an earnings perspective, really nice growth in earnings per share, a 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 in doing a great job of growing volume and controlling costs to improve margins. Overall portfolio yield increased up 24 bps year over year which is 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 up that much speaks to the volume that we've been doing at these much higher levels.

In terms of production, I mentioned $258 million for the quarter, up from the previous quarter, down significantly 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 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. One, the portfolio seasoning. Just as a reminder, last year, we did $1.7 billion in originations, and delinquency tends to peak 24 to 36 months after originating new loans. So as the portfolio seasons, we'll see some of that delinquency come on.

Two, 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. But if not, were 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 we continually monitor our portfolio and look at delinquent assets. And based on everything we've seen and reviewed, we don't expect our results to be any different than what we've historically seen.

And in terms of financing and 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. This was a great transaction for us because it continues to down the theme of non-mark-to-market financing. Virtually, 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 risks. So we think this is a more elegant solution to control risk, and it was a great transaction for us.

And then I guess I would just say in terms of liquidity, $72 million. So we're in real good shape there with all of our financing counterparties and have plenty of capital to go.

Turning to page 4, very straightforward and simple nice earnings growth, adding to book value as we've 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.

On page 5, we think that we've created a lot more value than what the GAAP book value would indicate, and this is a buildup of the -- not only the inherent value in the platform, but also what we think is created in the future value of the business and a potential premium if someone were to be interested in acquiring the business. So suffice it to say, we think come the economic value of the company is much higher than the book value on a GAAP basis.

So with that, I'll turn it over to Mark on page 6.

Thanks, Chris. Hi, everybody.

Continuing with the financial results on Page 6, we can see the improved loan production as interest rate increases has slowed down. Q2 production was just under $259 million in UPB and, as Chris mentioned, a 19.2% increase from the 270 million in Q1. Weighted average coupon for both Q1 and Q2 productions of, so far, year to date in 2023 was 11%, and that's about one 3.25% year-over-year increase over Q2 of 2022 in our weighted average coupon. The strong production increase in Q2 at the 11% WAC demonstrates the continued borrower demand for our products.

Moving to page 7 shows the strong portfolio growth attributable to the improved loan production. Our total loan portfolio as of June 30 was $3.7 billion. That's a 3.4% increase from Q1 to 20% increase from Q4 of last year. The weighted average coupon on our overall portfolio as of June 30 was 8.4%. 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%.

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 costs in warehouse line. And 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 nonperforming loan rate for Q2, as Chris mentioned, increased to 10%, driven by a combination of portfolio seasoning. And as Chris mentioned, we did $1.7 billion last year. We did $1 billion of that really in the first six months of last year. 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 first six months of '22, we funded the $1 billion. Our special servicing department is being more aggressive in collecting the efforts on the NPL loans. Of that 10% nonperforming, 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 payoff from the paid currents that we see on the resolution table. That's 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 million in nonperforming UPB for a net gain of $1.5 million, 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. The CECL reserve as of June 30 was $4.6 million or 15 bps of our outstanding loans held for investment amortized cost balance. Our CECL reserve has been very consistent between 15 and 16 bps over the last five quarters. And just as a reminder, the loans carried at fair value that we started doing in fourth quarter of last year are not subject to a CECL reserve.

Q2 charge offs are shown on page 11 at $717,000 for the quarter, second quarter. However, subsequent to closing the books for the quarter during our post-close internal review process, we discovered that one of our servicers had received funds from a borrower in the amount of $393,000 that had not been applied to the outstanding loan balance. Taking this borrower payment into consideration, the actual Q2 charge-offs for Q2 were $324,000, not $717,000 or 39 basis points of nonperforming loans, not the 87, which is actually a decrease from Q1.

Management determined that the adjustment was immaterial to the overall results of the quarter, and 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, $72 million comprised of $34 million in cash and cash equivalents and another $38 million in available liquidity on our unfinanced finance loan collateral. As mentioned, we issued two securitizations in Q2. In April, we issued the 2023-1R security. That security is a Re-REMIC and refinanced retained tranches from previous securitizations. So we re-leveraged securitization tranches that we kept to improve securitizations.

This new type of financing demonstrates the diversification of 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 million in cash proceeds to us. And then in May, we issued the second securitization 2023-2 which is one of our long-term normal securitizations. We issued about $202 million of securities.

And then finally, our available warehouse unused capacity as of June 30 was $573 million, so still plenty of capacity to continue pursuing growth in our production.

And it wraps up the financials, and I'd like to turn the presentation back to Chris for a discussion of Velocity's economic outlook. Chris?

Thanks, Mark.

Looking forward, we think the market is doing very well especially in light of all of the Fed action. We continue to see very strong real estate market. I think some of the areas that were overheated have cooled down, which is good. And in terms of credit performance, we're 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 demand for our product. So we expect to grow the portfolio and grow earnings. So I think, all in all, everything looks really good.

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

(Operator Instructions) Steve Delaney of JMP Securities. Please go ahead.

Good afternoon, everyone. Can you hear me?

Yes.

Great. Well, I [had to be on my cell] so I apologize for that. Nice quarter again. I think we say that every quarter (inaudible)

Never gets old, Steve.

Yeah, for sure. Could you speak a little bit about '23-2 and just how that execution went compared to '23-1?

Sure. Yeah. So I think I would say it was pretty similar, not quite as strong demand as we saw in dash one because it was kind of pre the banking crisis. And I think things were really starting to tighten up at the beginning of the year. And then that obviously put a damper on things, 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.

Wow, okay.

We're getting good response there. So I think we're seeing good activity from bond investors.

Because the absolute rate, you're getting 11% coupons and a lot of that obviously passes to the bond buyers. Is that factor -- are people looking at that as a positive or they're scared that that's going to lead to poor credit performance without much carry?

Yeah, I would say it's probably the former, not the latter. I mean, when 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 asked, why is that the case and et cetera. But I haven't heard anyone say it's a concern or a predictor of bad things to come.

And one for Mark, if I may. And then that will be it for me. Nice book value growth in the quarter. We had a couple of residential credit mortgage rates in the last 24 hours report. And they use securitizations, and there were declines in book values. And obviously, they marked both sides of their securitizations. I'm sure there were some credit spread impact in this, but we saw 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 held-for-investment, you have your fair value portfolio. I guess I'm really asking about the fair value portfolio and how that worked out particularly -- as in the second quarter, given the increase we've seen in the tenure?

Yeah, and you're exactly right. I mean, the one thing -- remember what we did, we started marking our loans or loan originations to fair value beginning with Q4 last year, October 1 of last year.

Right.

But then starting this year, first of 2023, we also elected to mark our securitizations at fair value. So you're right, there was some yield decline in the fair valuation of the loans quarter over quarter. But then on the converse side because, remember, our securitizations are fixed rate securitization that exactly equal, too much hedge, so natural hedge on the loan. So when you have a fair value loss on the loans, our natural hedge is kicking in, and we picked up -- you'll see fair value gains on the securitizations.

Look at the financials we put out in the Q, you're going to see good size, fair value gains quarter over quarter on the securitization. So that kind of what maintains our growth in book value is that natural hedge for that securitized portfolio.

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

Thanks, Steve.

(Operator Instructions) Stephen Laws, Raymond James.

As Steve mentioned for me, nice quarter again. It seems pretty recurring here, and I know you guys see some tailwinds from the business. And Mark, really want to start with that. Can you talk about that competitive landscape or lack thereof from the banks? I know three months ago we talked on the call, and you talked about being able to improve your underwriting credit standards on new production and then maybe getting some stuff that [possible 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?

Sure. That was directed to Mark?

I think it was for Chris.

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

Okay, got it. Okay.

Sorry, Mark. I just (inaudible). That's for you, Chris.

No problem. Yeah, I would say the environment feels pretty similar to where it was in Q1. I don't think it has gotten worse or better. But we'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.

Great. And then as far as your origination volumes, as you look out, and apologies if you've covered it in the first couple of minutes, I was a touch late. But it seems like it picked up a little in Q2. I know early in Q1 you guys had sort of become cautious, got more active later in the quarter.

Do you think you're at your normal run rate here for the second half? Do you think things are more likely to maybe pick up, go down? How do you frame volume as we move through the back half of the year and into '24?

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

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

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

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

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