Velocity Financial Inc
NYSE:VEL
Earnings Call Analysis
Q4-2023 Analysis
Velocity Financial Inc
The company closed out the year on a high note, delivering yet another record quarter, which helped make 2023 the most successful year in the company's history.
Despite a tight credit environment where banks are hesitant to extend credit, the company actively expanded its portfolio by capitalizing on favorable risk-adjusted spreads. Relative to the broader financial market, recent indications from the Federal Reserve suggest an incoming halt to rate hikes, which has already begun to revitalize the securitization market—a positive sign for the company moving forward.
Looking ahead, the company is riding a wave of positive momentum into 2024, with a clear objective dubbed '5x25.' The plan is to scale the portfolio to a minimum of $5 billion by 2025, reflecting commitment to growth and added value for customers and shareholders alike.
The company's effective management of finances is underscored by its first deal of 2024, which saw a substantial reduction in the cost of funds by over 100 basis points, showcasing a prudent approach to capital allocation.
Through the entirety of 2023, the company achieved robust production growth, maintaining a constant weighted average coupon rate of 11% for new originations across all four quarters. This stability in interest rates has been a key factor underpinning the company's strong production metrics.
A highlight of the financial results is the strong performance of the special servicing department, which through diligent collection efforts has continually resolved non-performing loans (NPLs), contributing positively to the company's financial health. Specifically, the fourth quarter saw resolutions of almost $71 million in unpaid principal balance (UPB) of NPL loans, cumulating to over $225 million resolved UPB for the year, for a gain of $5.5 million or approximately 2.5%.
The company has maintained a steady position with respect to its CECL reserves, ending the year at $4.8 million, representing 17 basis points of the total non-fair value loans held for investment. These reserves have been notably stable for the past five quarters. Furthermore, the net gains realized on loan charge-offs and real estate owned (REO) valuation underscore the company's thorough approach to asset management, amounting to a net gain of $5.5 million in the year.
The company concluded the year with ample liquidity totaling $63 million, which is a testament to its financial management strategies. This liquidity includes $41 million in cash and equivalents, with an additional $22 million available from unfinanced collateral. Additionally, in the fourth quarter, the company successfully issued $203 million of securities, reflecting ongoing confidence in its securitization operations.
The company's business model is distinctive, embracing a commitment to own the risk associated with its portfolio, leading to more disciplined decision-making. This 'eat our own cooking' philosophy is supplemented by a unique balance sheet approach that aligns the interests of being both investor and originator, enhancing strategic alignment through the entire loan process. The company's focus on an underserved niche that remains largely overlooked by larger institutions positions it well to maintain a competitive edge.
An integral part of the company's success in resolving assets efficiently is attributed to the seasoned expertise of their asset management team, coupled with the company's conservative approach at the underwriting stage, which ensures a positive influence on outcomes.
Expansion efforts have included onboarding additional staff with preexisting business relationships and an expansion of the training program for junior account executives. This strategic hiring process has been primarily geared toward market penetration and gaining market share by bolstering the loan production team.
The company's lending strategy prioritizes presence in large, more liquid metropolitan statistical areas (MSAs), reinforcing its aim for market penetration over geographical expansion. This long-standing consistency in preferred lending locations has been a deliberate choice, supporting stable growth in familiar territories.
With a 'pretty long runway' ahead, thanks to the newly acquired capital, the company is well-positioned for growth into the following year. This financial preparation aligns with the company's philosophy of self-reliance, as it retains and manages the risk inherent in its loan portfolio, ensuring a sustainable growth trajectory in line with its long-term plans.
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Good day, and welcome to Velocity Financial's Fourth Quarter Conference Call. [Operator Instructions] Please note this event is being recorded.
I would now like to turn the conference over to Chris Oltmann. Please go ahead.
Thanks, Ed. Hello, everyone, and thank you for joining us today for our discussion of Velocity's Fourth quarter and full year 2023 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 fourth quarter and full year 2020 results, and you could find the press release and accompanying presentation, we will refer to during this call on our Investor Relations website at www.velfinance.com.
I want 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 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 we appreciate everyone joining our fourth quarter earnings call. First off, I'd like to congratulate my teammates as we delivered another record quarter to finish 2023 as our best year in the history of the company. Our execution was outstanding across all segments of the business. We consistently grew originations and expanded our platform capabilities to deliver products that our customers need and want.
Banks continue to be constrained in extending credit, which has allowed us to grow our portfolio with compelling risk-adjusted spreads. While there continues to be stressed in some segments of the larger commercial real estate markets, our single-family rental and small neighborhood serving commercial properties continue to perform well. We see healthy demand with limited supply in our niche, which continues to drive modest price appreciation for these types of assets.
The most significant development impacting us in Q4 was the change in Fed policy. As everyone knows, the bond markets responded quickly and favorably as the Fed signaled the likely end of rate hikes. We saw an immediate improvement in the securitization market as our first deal in 2024 benefited from lower base rates and tighter spreads where we realized more than a 100 basis point decrease in our cost of funds. We continue to see very healthy execution for new issuance and believe there is more demand than supply available to our bond investor base.
In terms of credit, our portfolio is performing well, and we remain disciplined in following our credit process without sacrificing margin. As a result, we improved our margins throughout the year by increasing yields and controlling expenses, which drove a 43% increase in our annual pretax ROE.
While delinquency remained stable in the fourth quarter, our asset management team resolved just over $70 million of NPLs favorably, and they deserve credit for an outstanding job.
Looking forward, we have great momentum heading into 2024, and we're focused on our 5x25 objective to grow the portfolio to at least $5 billion by 2025. Our entire team is committed to delivering value to our customers and shareholders, and we're excited to continue building upon our success.
With that, I'll turn over to our presentation materials and start with Page 3. Obviously, a great quarter of core net income up 77% from the prior year. Great performance in terms of NIM, as well improved in the fourth quarter, up 18 basis points sequentially, maintaining our strong production growth.
I mentioned pretax ROE. And you can see in the fourth quarter, we had a very healthy increase versus the prior quarter.
Turning to production. The portfolio of $350 million of new UPB. Exceptional growth there as we continue to execute on our plan and did a great job of maintaining the coupon.
In terms of the total portfolio, we're now over $4 billion, and as I mentioned, headed to $5 million.
From a nonperforming loan perspective, as I mentioned, those assets remain stable, and we continue to recognize positive gains of a little over 102% in the fourth quarter.
In terms of financing and capital, we mentioned the securitization market continues to be very strong. We closed the deal in the fourth quarter and 1 in early January. You also probably saw our press release that we issued $75 million of new growth capital to continue expanding the portfolio and putting on new assets in an accretive way.
Turning to Page 4. Walking through book value and adjusted book value. We highlight on the left some of the core adjustments that we made. There's sort of a onetime tax liability that offset some of our GAAP earnings and bought the core results down a touch for the quarter. But again, very strong results that we're very proud of.
You can see the book value growth in the upper right section of this slide, we show the bar chart growing to book value of $13.49 a share.
We added 2 new columns on this slide from our previous presentation, and I want to kind of walk folks through what this represents and why we put this here. The green bar that says adjustment in $3.32 per share is -- represents the fair value mark on our -- all of our assets and liabilities that are carried at cost. If we were allowed under GAAP to mark all of those assets to fair value, you'll see in our financial statement footnotes this is the math that gets us to fair value. Many of our comparable sets and peers that we get compared to carry their assets at fair value. As you folks know, we made the election in Q4 of last year to move to fair value accounting. So we wanted to show everyone that we believe the true value that we've created is actually much higher than the GAAP book value. And so this far right column of $16.81 is a reflection of that potential gain if we were under GAAP allowed to mark everything to fair value we come up with an adjusted book value of $16.81 a share.
So this is where the company is heading in the next 4 to 5 years. We expect almost the entire portfolio to be held at fair value. So we thought it would be helpful to walk folks through kind of how we get from where today's book value is, where we think fair value sits and where we expect it to go in the future.
With that, I'll turn the presentation over to Mark to take over on Slide 5.
Thanks, Chris. Hi, everyone. Our fourth quarter capped a very successful 2023 that further advanced Velocity strategic growth initiative. On Page 5, our loan production ended the year strong, as Chris mentioned. Our Q4 production was a little bit over $352 million in UPB. That was a 21% increase from the $290 million in Q3 and almost a 27% increase in production year-over-year. Our strong production growth during 2023 was achieved with weighted average coupon for new originations for all 4 quarters during the year, remaining constant at 11%.
The growth in the originations in the second half of '23 was also at higher credit levels with the weighted average LTV for the last 6 months of the year at 65%. The strong 2023 production growth at the higher weighted average coupons demonstrates the continued borrower demand that we've had for our product.
As a result of this strong growth in production, Page 6, shows a similar growth in our own portfolio. Total loan portfolio at the end of the year was $4.1 billion. As Chris mentioned, it's the first time in our history that our loan portfolio itself has been at a $4 billion threshold. That's a 5% increase from Q3 and a 16% increase in the loan portfolio year-over-year.
The weighted average coupon on our total portfolio as of December 31 was 8.88% and a 25 basis points increase from Q3 and a 93 basis points year-over-year. And the portfolio loan-to-value ratio actually declined slightly to 67.8% as of December 31 compared to 68% at both Q3 and end of year 2022. And again, that was predicated based on, again, the last 6 months of 2023 coming into a 65% tighter credit spread LTV.
On Page 7, our Q4 NIM increased by 18 basis points from Q3 and 68 basis points year-over-year as our portfolio yield increased quarter-over-quarter by 32 basis points and year-over-year by 119 basis points, while our cost of funds only increased by 12 basis points for over quarter and 52 basis points year-over-year. The strong growth in originations, coupled with the widening NIM, is reflected in our 2023 earnings.
On Page 8, our nonperforming run rate at the end of the year decreased to 9.7% compared to 10.1% at the end of Q3. Once again, the ongoing strong collection efforts by our special servicing department results in continued resolutions of our NPL loans at very favorable gains.
If you look at Page 9, it highlights the continued success of our NPL resolution efforts.
In Q4, we resolved almost $71 million UPB of NPL loans and REOs for a net gain of $1.5 million or 2.2%. 2023 in total, we resolved a little over $225 million UPB of NPL loans and REOs for a gain for the year of $5.5 million or 2.5%.
Page 10 presents our CECL loan loss reserve and our net loan charge-off and REO activity. On the left-hand side, the CECL reserves of the end of the year was $4.8 million, or 17 basis points of our outstanding non-fair value loans held for investment portfolio. Our CECL reserve has been consistent at 15 to 17 bps over like the last 5 quarters. Number of the CECL loan loss reserve does not include any loans being carried at fair value as they are not subject to the CECL reserve.
The table to the right on Page 10 is a new presentation, which shows our net gain loss from loan charge-offs and REO activities during the year. Management feels this presentation provides an enhanced view of our loan resolution valuation activities from the time the loan is charged off and converted to REO through the REO sales process.
U.S. GAAP requires a separate accounting and separate presentation in the financial statements for loans and REOs because they consider different type of instruments. But operationally, management views the REO for closure and related sale valuation activities as an integral part of the entire loan resolution process.
For 2023, we had a net gain on loan charge-offs and REO valuation activities of $2 million, and in 2022, a net gain of $5.5 million, further kind of demonstrating the strong resolution activities from kind of a loan to a disposal process.
Page 11 shows our durable funding and liquidity position at the end of the fourth quarter. At the end of the year, total liquidity at the end of the year was $63 million. That's comprised of about $41 million in cash and cash equivalents. Another $22 million in available liquidity that we have on unfinanced collateral.
We did issue on securitization in Q4. In November, we issued, as Chris mentioned, the 2023-4 security totaling just under $203 million of securities issued.
Our billable warehouse line capacity at the end of the year was $554 million with an overall maximum line capacity of $860 million.
Subsequent to year-end, we completed our first securitization in 2024, totaling just under $210 million of securities issued. And again, as Chris mentioned, in February of '24, we issued $75 million of 5-year fixed rate senior secured notes to support the continued growth of the company.
With that financial recap, I'd like to now turn the presentation back to Chris for his overview of Velocity's outlook on its key business drivers. Chris?
Thank you, Mark. Looking forward, we think the market is in a good position, particularly in our niche, expect to see strong demand there and continued favorable asset resolutions.
Credit, I think, remains tight, certainly from the banks and the credit unions and other institutions like that. So we think that's potentially a strong tailwind for us.
Capital. We're in a good position, and the securitization markets are definitely helping us right now, and we're very hopeful about future issuances in the market looking forward.
And then from an earnings perspective, we think there's significant growth opportunities here as we continue to build out our strategy, develop new products and grow the portfolio. So overall, we look very favorably into '24 and excited to continue to grow the firm.
With that, that prepares our -- sorry, concludes our prepared presentation, and we'll open it up for questions.
[Operator Instructions] And the first question today comes from Sarah Barcomb with BTIG.
So I was hoping you could talk a bit more about your outlook for production this year and funding that new production. You've obviously been a frequent issuer in the securitization market, but now you've got the secured notes and excess warehouse capacity. How should we think about both the production mix and the financing mix for 2024?
Sure. Sarah, thanks for that. I think we released our year-to-date numbers through February, and you can see the volumes are continuing to be quite strong. So we expect a significant uptick in volume this year going forward.
In terms of the mix, we're still seeing a little bit more of the 1 to 4 than we're seeing in the small multifamily and small commercial. That could change over the year. We'll see how things shake out. But right now, it's running kind of consistent with what we saw in the last 3 quarters, I would say, of '23.
And then from a financing perspective, we intend to securitize every 2 to 3 months. So we should do at least 4 to 5 transactions this year. We like having the extra warehouse capacity to support that growth and to make sure that we time our securitizations effectively. But from a risk perspective, our goal is always to get the debt termed out as quickly as we can and get these assets into a nonrecourse securitization as quickly as possible.
Great. And then just a follow-up for me. Do you have any updated thoughts on the outlook for the Century acquisition and when we could start to see that fee and comp kind of pick up? Any color on those volumes with that license?
Yes. Yes. We've -- we think this year is going to -- sort of towards the second half of the year, we're going to see some pretty significant fee income come through. They have a very large pipeline. And unfortunately, working through HUD is often very slow and cumbersome. But the pipeline is almost 4x larger than it was last year. And we're -- I know we've recently just got a couple of approvals out of them. So I think second half of this year, you're going to start to see some significant fee income flow through from them.
Great. Thank you and congrats on the quarter.
Thanks, Sarah.
Our next question comes from Don Fandetti with Wells Fargo.
So it looks like you guys are hitting or at least you're in a little bit of a sweet spot here. I guess as you sort of look at your 5 and 25, that's pretty strong loan growth. How do you think about that from a risk management perspective, just given what we went through for the last 3 to 5 years?
And then can you expand secondarily on what you're seeing from banks and competitors? Is it just good? Or is it getting increasingly better competitively?
Sure. On the first question, I mentioned in my opening remarks, we just have to stay disciplined on credit. We don't need to reach our volume if we're very disciplined in kind of sticking to where we like to extend credit. So in terms of risk management, I think we'll stick to what's been working over the last 5 years. And I don't see much of a change there. We are pretty in touch with our markets, and we're nimble, and we'll stay aware as to any changes. But right now, our outlook is things are positive. And as kind of leads into your second question, the banks continue to be constrained. We think that, that's going to lead to a driver of that volume, whether we hit that goal in the first part of '25 or the very end of '25 probably is not as important to us maintaining our margins and maintaining our credit discipline and when we get there, we get there.
But I would say for sure, filling in your second question, the banks are only lending right now to their best customers. And below that, it's a struggle people. So we're seeing better borrowers for sure, come to us that we normally would not see saying that they need financing and they need capital.
Our next question comes from Stephen Laws with Raymond James.
I guess, first off, congrats on a very strong close to the year, very impressive quarter. To touch back on Sarah's question about production, you mentioned 250 I believe, is in the press release for the first 2 months, and I've kind of always thought that Q1 is a little seasonally light. What do you think kind of as you look out, what is your expectation for a quarterly number? I mean is it $400 million? Or kind of where do you think that settles in?
Yes. We don't provide exact forward guidance on that. But you're right, the fourth quarter is usually a touch lighter. So I would expect growth as we go through the year, much like we did last year, obviously, barring any crazy disruption or circumstance. But I think we would expect sort of Q1 run rate to tick up slightly throughout the year.
Great. Appreciate that. When you look at the capital, you just raised $75 million through the senior secured notes, how much growth can that support? Have you've been considering your ATM at all? And when you look at that, do you look at it versus the GAAP book value versus the adjusted book value that you've provided in the new slide deck? And how much new production and growth can your current liquidity and capital position support?
Yes. Good question, Stephen, this new capital that we took down gives us a pretty long runway well into next year in terms of our growth ambitions and plans. So we feel very good about our capital position and supporting that growth. As you know, we retain all our earnings. So that helps fuel that growth. And so I think we've not only feel comfortable and good about that, but we have a lot of sort of flexibility and other things that we could do. So I would say we're confident in our ability to work well into next year.
Great. And then one last one, if you don't mind. You guys have been remarkably successful in the resolution and REO front. Can you talk about that process? Most others that I follow up in delinquencies and problem loans kind of ticked up. You guys actually ticked down slightly. You continue to generate gains on those resolutions. But can you talk about how you guys run that process internally, what the average time is as far as getting something from where it goes, say, delinquent to getting a resolution? Maybe give us a little more color on what's driving your success there.
Sure. You bet. I realize I forgot to ask your earlier question about the ATM as well. We will utilize the ATM. As you know, our trading volume is light. So, it's not a huge generator of capital for us, but we're hopeful as we continue to go forward. People will understand the story, and we'll be able to tap that more.
In terms of asset resolution, it varies by state. The broader states, Texas, you can foreclose in 60 days. California, those types of places, a trusted states. The other states that you have to go sort of judicially in your foreclosure, New York, New Jersey, Florida, those types of states, those take up to 2, 3 years to get a resolution. So it's -- we take that into account when we do our underwriting, and it's really important to make sure that we have a lot of equity when we make these loans because default interest and interest is accruing all during those periods. So we can get some really nice gains in those longer states, assuming we've gotten the LTV right at the front end. So it's a combination of very disciplined underwriting, tough focus on real estate values and then our super talented asset management team that really knows how to take an asset and get it resolved as quickly as we can. So it's a combination of all those factors and a lot of experience in this particular niche that guides us through where to be aggressive and where to be conservative on the front end, which ultimately affects the back end.
Our next question comes from Steve Delaney with Citizens JMP.
Look, I mean, fantastic quarter, great year. You guys just keep defying the roadblocks, I guess. And Chris, you guys built this thing over the last 25 years. And what is so different about your business model that you can continue production flows when every other residential, commercial mortgage lender was facing headwinds in volume and saw severe reductions in originations. And I think I know what it is, but I want to hear from you. I mean there's -- is it that your product is so specific and unique and fits a niche that is less rate sensitive, economically sensitive? Just try -- I think it's telling us something about your business that is unique. And I just would love to hear your -- so that I can relate it to clients tomorrow exactly what the special sauce is that why you can move forward while others are standing still are going backwards?
Sure. Thanks, Steve. You know we can't give away the secret sauce.
I guess not. That wouldn't be. That would be first [indiscernible].
So I would attribute it to 3 things One, our company philosophy that we eat our own cooking. Everybody here knows that when we make a loan, it goes in the portfolio and we own the risk. I think that's really important. A lot of other mortgage platforms are set up to sell off risk, and they don't ever see the final resolution of an asset and then the life of that asset and what happens to it.
Two, I would say, our unique sort of balance sheet approach. In other words, putting things in portfolio and securitizing it. We're really unique in that we're basically the investor and the originator all in one, and most mortgage companies are split into 2. And I think that sort of each of those functions have different drivers and different goals. By combining the 2, we feel like we get better alignment all the way through the process.
And then number three, I would say, you're right, the niche that we focused in is clearly underserved, and it has been for a long time and continues to be. These assets are tricky to originate. They're tricky to value. And quite frankly, most of the other institutions overlook them or don't get that excited about them, and it's allowed us to be a provider of capital.
Yes. I mean the average loan size is the thing that jumps off the table. To me, 350,000 other people are just so much larger. So economically, I mean, it's -- other people wouldn't make -- it wouldn't move the needle, but it certainly does for you with your volume.
So -- and I noticed you changed your book value presentation a little bit. There are all kinds of reasons I'd like to -- you, I think you've made your point the market in terms of sort of the franchise value and other things, just looking at your stock at 124% and the commercial mortgage REITs were 76. I think people realize there's something different about your business. I like this because fair value is an extremely important accounting and economic measure, especially in difficult markets, right, where assets were -- might have to be sold. So I applaud that move. I don't think you'll you have any problem there or people saying, why is that number lower than the economic book value that you through out.
Mark, you could help me. One quick follow-up. I know, I've rambled. On Page 10, in the REOs, just could you explain those, the adjustments like on the gain on transfer of REO and then the REO valuations? Just help me understand the caking and then the write-down, it appears on the REO, how those kind of work through?
Sure, Steve. So under on the GAAP accounting, when we foreclose on a are property, we now acquire real estate, so we have to write off the loan and put the real estate on the books. And whenever you're foreclosing on REO that real estate has to initially come on your books at fair value. So for example, given all TVs, if the loan is a $350,000 but the REOs were $440,000, when I foreclosing REL put the our books for $440,000 we win of the $350,000, I've got a $90,000 gain on transfer REO company under the higher a value.
Now once that ARO is on the books is carried at lower of cost to market [indiscernible]. So on a go-forward basis, then you have to value that REO every period, every quarter, wherever going forward, and then you're going to mark that up or down based on the lower cost to market, your cost is considered that initial fair value when you put it on. So my example, the $440,000, so $440,000 if that, let's say, 2 quarters later, if whatever ease the market changes and the REO is worth $420,000, now I have a $20,000 valuation REO loss. And you can mark it back up again, but you can only mine back up to its initial cost, which is $440,000So because the returns are back to 4 market up because of 470, I can't do anything with it. I'm limited with a ceiling of that initial fair value brought enough. That's that fluctuation going forward is at lower cost to market.
That helps very much. And the, just comparing '22 to '23, I would think that higher interest was really the thing that caused that fair value change of your...
Yes, Interest rates definitely played into that. Yes, Steve, that's right.
Sure. Listen, congrats on a great year.
Thank you. Appreciate it.
[Operator Instructions] Our comes from Arren Cyganovich with Citi.
I just had a quick question on your production continues to grow, and I was wondering is that just more productivity from existing brokers that you're using, is it expansion into different geographies? Maybe you could talk a little bit about what's giving you that success on the production side.
Yes. Sure, Arren. We added we continue to grow by adding sales folks. We do get productivity gains from account executives for sure. But we also added some folks last year, and we'll add some more this year. We like to find people who have preexisting relationships and a book of business to bring. We also have an internal training program where we take junior account executives and train them up. So I would say that most of that growth is market penetration and taking market share gains through adding new loan producers.
Okay. So you're not really expanding into new geographies, taking that much?
Yes, not really. We like to stay in the more liquid large MSAs. So if you look over the years, we've been pretty consistent about where we lend and we like to stay there. So I think it's more of a market penetration than it is new geographies.
Thank you. This concludes our question-and-answer session. I would like to turn the conference back over to CEO, Chris Farrar for any closing remarks.
Thank you all for taking the time to hear our story. We're going to continue to work hard to execute on our plans and look forward to speaking to everybody next quarter. So thank you.
Thank you, everybody.
The conference has concluded. Thank you for attending today's presentation. You may disconnect.