Velocity Financial, Inc. (VEL) Earnings Call Transcript & Summary

Good day, and welcome to the Velocity Financial, Inc. Second Quarter 2022 Earnings Conference Call. [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.

Thank you, 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. This afternoon, we released our second quarter 2022 press release and the accompanying presentation, which are available on our Investor Relations website. I have to remind everybody that today's call may include forward-looking statements, which are uncertain and outside of the company's control. 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...

Excuse me, Mr. Oltmann?

Yes.

I'm sorry to interrupt. Your voice is breaking up. Is it possible to pick up a handset by any chance? We're not hearing everything.

Do you hear me better now?

Yes, I believe so. I'm going to -- I'll -- I'm not sure if you'd like to maybe just begin from the start just to make sure everyone hears the safe harbor, et cetera.

Okay. Okay. Thank you for joining us today, everyone, for Velocity Financial's Second Quarter 2022 Results. Joining me today are Chris Farrar, President and Executive Officer; and Mark Szczepaniak, Velocity's Chief Financial Officer. Earlier this afternoon, we released our second quarter 2022 press release, the accompanying presentation, which are available 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 affect results, please see the risk factors and 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 today's call is being recorded and will be on the company's website later today. 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 Mark -- our CFO Mark Szczepaniak's 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. Beginning to see a cool down in the real estate markets, 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 6 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 in 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 a 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 6 months of the year, over $1 billion, which is more than twice the amount that we had done the prior year. So fantastic growth across the platform. Ended the quarter with $3.1 billion in 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 lose dramatically as borrowers [ care ] and NPLs get resolved. From a financing and capital perspective, we completed 3 securitizations during the quarter. I think that speaks to our strength out there and 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 on $134 million of liquidity 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 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 here just -- sorry, this slide just highlights our unique portfolio approach of building book value and trying to maximize shareholder return with limited volatility. So a 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 them 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 6 months of '21, 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 6 months. So we're still seeing very strong demand for our product. We have $445 million funded in Q2. And as we've seen a little bit, we've been raising our WACs on our loans, on 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. We'll 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 6 months of the year. So very happy to see that. On Slide 6, the production comes in strong. The loan portfolio is growing accordingly because we're putting most of that into our portfolio or 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 the $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. Slide 7, the net interest margin. And we're seeing this 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 4.83%. And we have said in some previous calls, that, that 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 a 4-point margin. And that -- you see we're normalizing back to kind of our normal run rate margins. We feel really good about that. And as our nonperforming loans are resolved, the default interest and prepayment fees have kind of started to normalize because our NPL rate has come significantly down, and we'll take a look at that. But while we're doing that, we're still maintaining that spreads. So if you look at the right-hand side, the portfolio yield and cost of funds, you can kind of see, 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 '21 into the first quarter of '22, we lowered the WAC on the loans, still maintained 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 8, the asset resolution activity. We continue to do -- see straight -- strong resolutions on our NPLs. 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 3.5, 4-point gain on our resolutions of NPL loans, and we're at 11-point gain for Q2. And as Chris mentioned, some other 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 painful for a $3.3 million gain, where Q2 of last year was $21 million but even put 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 traditional states ], where it takes about 1.5 years or 2 years to settle those loans, some of those are now finally coming through. And remember, we've got that 4-point default interest tacked on. And that's accruing the whole time it's in network closure process. So as these borrowers are now paying off those loans because we're getting to the point where we can foreclose on the properties, they don't want to lose the property, so 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 gains coming through. And one thing to point out, it's not on this slide, but with that growth in production, the growth 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 now on these slides, year-to-date, our core diluted EPS is $0.67 a share versus $0.45 a share for the first 6 months of '21. So year-over-year or 6 months over 6 months, you've seen a 50% increase in that quarter 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 were 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 4-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 on 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, our CECL reserve, it remains very consistent in terms of basis points of reserve on UPB. That's in the kind of the bottom left-hand chart. You can see we were at 19 bps back in Q2 of '21. We kind of had additional reserves on there, not knowing the uncertainties of 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, 17 basis point spread, the dollars of the reserve are going to grow accordingly. The key point is on the right-hand side of the bottom, you see our charge-offs. And our charge-offs has been running consistently low, and that's historical, too. If you look at the last 4 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 4 securitizations already in 2022. If you think about it, we did 4 all of last year, and we've already done 4 during 6 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 problems getting these 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 achieved 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 -- I'm sorry, yes, the sequential structure. And the sequential structure, as it pays down, gets more expensive. So that was a higher yield deal. We were able to collapse that and resecuritize it in our pro rata structure and at actually, a lower cost. And then the old MC1, the old 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 as a turbo went right to the bondholders, paid them down and our equity just kind of kept growing. We were able to releverage that almost like a 75% advance rate and generate quite a bit of liquidity, as Chris mentioned. So we're able to fill in 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 another $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, 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 safe there. And there's 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 2 more securitizations this year. And I think from an earnings perspective, I just want to continue to focus on managing the portfolio, providing that stable spread and looking for opportunities to grow both organically and strategically. So with that, I will turn it back over to Andrew, we can see if there are any questions.

[Operator Instructions] The first question comes from Arren Cyganovich with Citi.

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 could talk about how the cadence happened throughout the quarter.

Yes, Arren, good question. I mean I think the right guidance is kind of at 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 securitizations?

Yes. So they're definitely pricing a lot wider than certainly '21. '21 was a banner year for us, and we were getting some incredible pricing there. So -- and I would say they're pricing a little wider than even before '21. 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 think we'll be there. It obviously depends a lot on where the market goes from here, but we're feeling like we're back in 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.

[Operator Instructions] The next question comes from Steve Delaney with JMP Securities.

I guess congrats on a really strong quarter and obviously, a very challenging market. And Mark, congrats to you from another former public company CFO. It's tough work, man, so great job.

Thank you.

Chris, you talked about distressed 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 a warehouse somewhere? Or is there any interest in infrastructure and any product expansion opportunities?

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, we -- I think you're largely seeing assets that are probably hung 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 that 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 6 months, we may see something like that.

Okay. Yes. Okay. Well, that's -- for the last year or so, it's been just a matter of your own -- keeping things straight in your own kitchen, right? But I think you guys have really gotten yourself 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 8 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 in the -- just in the last few weeks, submissions have been very strong. So I think there's, what I call the -- kind of the sensitivity period where customers and clients, borrowers are kind of adjusting to things and then there's a -- like a hold back or a lull, if you will, and then people start to realize, this is the new reality and they transact. So we -- there was a little bit of an adjustment period there, for sure, but very pleased to see how strong submissions have been.

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 support that we've seen from everyone. So that will conclude our call. And thank you.

Thank you, everyone.

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