VEL - NYSE

Good afternoon, and welcome to the Velocity Financial Q2 2024 Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mr. Chris Oltmann. Please go ahead.

Thank you, Rachel. Hello, everyone, and thank you for joining us today for the discussion of Velocity's second quarter 2024 results. Joining me today are Chris Farrar, Velocity's President and Chief Executive Officer; and Mark Szczepaniak, Velocity's Chief Financial Officer. Earlier this afternoon, we released our second quarter results and you can find this press release and accompanying presentation that we will refer to today during this call on our Investor Relations website at www.velfinance.com. 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 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 would like to turn the call over to Chris Farrar.

Thanks, Chris, and thank you all for joining our second quarter earnings call. After the close, we reported another great quarter as our business continues to perform well across all segments. Our net revenue increased 41% over the prior year's quarter, resulting in a 23% increase in core earnings. Our originations were healthy with a 63% increase in volume versus Q2 '23. And importantly, we maintained our margins and credit standards. Our portfolio is performing well and our special servicing team continues to do a great job of resolving delinquent assets favorably. Our charge-offs remain low and we realized over $2 million in net gain from our REO activity this quarter. As a result of our increased originations, we issued two securitizations in April and June. Both deals priced well and saw strong demand from our bond investors. As a reminder, we're required to expense all issuance costs associated with those deals in the current period, which is a drag on current period earnings, but the trade-off has increased spreads going forward as we have no amortization expense to recognize on this debt. Real estate market is performing well for us and we continue to see strong demand for financing from our borrowers. Banks are still constrained and we're starting to see the market price and future rate cuts, both of which should be a tailwind for us going forward. I want to congratulate all my team members on another great quarter as I truly appreciate their commitment to excellence. We will continue to execute our 5x25 growth strategy to reach $5 billion in UPB by 2025 with the ultimate goal of rewarding all shareholders. That concludes my prepared remarks and we'll turn over to Page 3 in the earnings presentation to go through some of the numbers. As I mentioned, good strong growth in core earnings, up to $0.45 a share for the quarter. The NIM widened out from earlier of 2Q of '23 by 30 bps, again, showing up as a result of the increased WAC from new originations. In terms of loan production, $422 million in UPB and total portfolio growth on a year-over-year basis of 20%. The NPL loans were up slightly to 10.5%. And we continue to still see positive resolutions on those NPLs and expect to do that going forward. In terms of the financing capital, I mentioned earlier that we had done two securitizations during the quarter. We highlighted here that there was a $0.06 per share drag on current period earnings from that second securitization as compared to prior periods where we're typically issuing just one securitization. And as I said, that's sort of a timing issue. It will depend on going forward each quarter, how many deals we issue, but should also help in terms of the NIM going forward. Century Health & Housing acquired $3.6 million in MSRs from a bank that originated some recent Ginnie Mae loans. That was a great trade for us because we're continuing to build out the platform and establish new relationships with new borrowers for more business. In terms of liquidity, we're in a strong position there. You can see just under $84 million at the end of the quarter with plenty of warehouse capacity to go forward on. On Page 4, we break out the core adjustments here. And then also on the right-hand side, as most of you remember, there's a build up here to our adjusted book value per share. I will point out that we had a typo there. In the far right, if you add the $2.39 to the $14.52 of book value, it should be $16.91, not $16.81. So, we're correcting that as we hold the call and that will be on the website shortly. But again, continuing to grow book value nicely as we execute on our growth strategy and retain earnings on a go-forward basis. So, that covers it from me, and I'll turn it over to Mark on Page five.

Thanks, Chris. Hi, everybody. In Q2, we continued our strong 2024 performance. On Page five, our loan production for Q2, as Chris mentioned, was a little over $422 million in UPB. This was an 11.5% increase from the $378.7 million in Q1. Kind of to note, there were over 1,100 loans funded in the second quarter. So, it's a great demand for the product. The strong production growth during Q2 was achieved with the weighted average coupon for the new originations remaining at 11%, continuing a five quarter trend of 11% coupon. This growth in originations in Q2 was also a very tight credit levels with the weighted average loan to value for the quarter at 64.7%. And the strong Q2 production growth with the high WAC and the low LTV, again, demonstrates the continued consistent borrower demand for the product. As a result of the strong growth in production, Page six, we see a similar growth in Q2 for the overall loan portfolio. Our total loan portfolio as of June 30 was almost $4.5 billion, it's a 4.6% increase -- a 4.6% increase from Q1 and over a 20% increase year-over-year in the portfolio. The weighted average coupon on this portfolio as of June 30 was 9.25%, which is an 18 basis point increase from the Q1 weighted average coupon and an 85 basis point year-over-year increase. The portfolio weighted average loan-to-value ratio remained consistently low at 67.4% as of June 30. On Page seven, our Q2 portfolio NIM increased 19 basis points from Q1 and 30 basis points year-over-year as our portfolio yield component increased 27 basis points quarter-over-quarter and 74 basis points year-over-year, while our cost of funds increased only 8 basis points quarter-over-quarter and 43 basis points year-over-year. This quarter-over-quarter increase in NIM is mainly driven by, again, the strong loan production growth in the quarter and healthy spreads, the higher coupons and also due to the recent improvement in the securitization market, keeping the cost fairly low. On Page eight, our non-performing loan rate at the end of Q2, as Chris mentioned, was 10.5% compared to 10.1% for Q1. Our non-performing loan rate has remained consistent for the last five quarters and the ongoing collection efforts by our special servicing department continues to result in resolutions of our NPL loans at favorable gains. The table on Page nine highlights the continued success of the NPL resolution efforts. And again, on a trend basis, we continue to average about 2% or more overall gain on NPL resolutions over the last five quarters. Page 10 reflects our CECL loan loss reserve and also the net loan charge-off and REO activity. On the bottom left-hand chart, the CECL reserve as of June 30 was $5.2 million or 20 basis points of our outstanding non-fair value loans held for investment portfolio. The CECL reserve is within our expected range. The CECL loan loss reserve number does not include our loans being carried at fair value. It's only the amortized cost. The table to the bottom right shows our net gain and loss from loan charge-offs and REO-related activities during the quarter. And for Q2, we had a net gain on loan charge-offs, REO-related activities of a little over $2 million compared to a slight net loss of $800,000 for Q1. So again, doing really well on loan-loan charge-offs, selling a lot of these REOs and again in booking a net gain activity for the quarter. Page 11 shows our durable funding and liquidity position at the end of Q2. As Chris mentioned, our total liquidity as of June 30 was just under $84 million and that's made up of over $47 million in cash and cash equivalents and another about $36 million, $36.5 million in available liquidity on our unfinanced collateral. As a result of our strong loan production, we did issue two securitizations in Q2. April, we issued our 2024-2 security with $286 million of securities issued. And in June, we issued our 2024-3 security with almost $205 million of securities issued. Our available warehouse line capacity was $646.5 million at the end of the quarter with a maximum line capacity of $885 million. So, still plenty of available capacity on our existing warehouse lines to support future growth for the company. Now, I'd like to now turn the presentation back to Chris to overview Velocity's outlook on key business drivers. Chris?

Thanks, Mark. Yes. I mean I think looking forward, we feel good about where we're headed. We feel like the markets are healthy and see good activity both on the real estate side and the borrower side. In terms of credit, seeing a lot of mixed signals out there. Obviously, it feels like the Fed is probably going to do some softening here. But we do expect to continue to get those positive NPL resolutions on a go-forward basis. Securitization market is healthy and feels good going forward. So, we're very positive there. And from an earnings perspective, just continue to execute like we do and we think that things look very good for the future. So with that, we'll open it up for questions.

Thank you. We'll now begin the question-and-answer session. [Operator Instructions] The first question comes from Stephen Laws with Raymond James.

Hi, good afternoon. Congratulations on a very nice second quarter. Chris, I want to touch on Page five with the loan production. I mean, really strong across the board. And investor loans have rebounded from a little seasonality in Q1, showing pretty consistent growth in commercial and particularly short-term loan products. So, this $103 million [Technical Difficulty]. Do you think this is the right originations? So, what's your outlook [Technical Difficulty] would be great.

Stephen, I think you cut out a little bit there, but I think your question was just going forward, what do we think on production levels. Yes, I would expect for the rest of the year around this Q2 run rate feels right. And I think sometimes the product mix moves around a little bit, but it will be something like you're seeing here in Q2. And so yes, I think for the rest of the year, we think it should look pretty similar to that.

And do you have an update maybe on the adjusted book there and the rate moves quarter-to-date? Curious how that fair value mark may have changed as of end of July.

Yes. I mean if we were to mark today, yes, you're right, there would definitely be a change to the positive, obviously. It's going to be largely dependent on where things settle out at the end of the quarter. So, if things were to stay where they are today, yes, I think you'd see an increase in the overall book from the drop in base rates for sure.

And then lastly, Chris, comments around the [Technical Difficulty] have you seen any banks return to the market really continuing to put up 11% coupons? So probably, not too competitive, but curious about any [Technical Difficulty]?

Yes. Not hearing much there. Seeing a lot of borrowers come to us that I think normally would expect to be handled by the banks. So, I'm not really seeing any signs of that and everything that I hear is just -- they're very constrained and limited on the new credit.

Great. Well, congrats again on a nice brand. And thanks for the color [Technical Difficulty].

Thank you. Appreciate it, Stephen.

Your next question comes from Steve Delaney with Citizens JMP. Please go ahead.

Good evening everyone. And a great quarter. Just kind of remarkable, Chris, the consistency of your production and the market is the market. But do you -- if you come right down to it, do you tie that to your relationships with brokers and borrowers? And is it really a defensible market presence that you have that somebody is not going to just come in and undercut you on rates and steal those -- that loan flow? It's the franchise, right? It's the brand.

Yes, I think so. I think we've always believed that this was an underserved niche. It's highly fragmented. There are a lot of different players out there. And we kind of just stick to our knitting and -- because we are a portfolio lender and we have this spread income that comes in, we don't feel the same pressure that other originators do to always put as much volume on the sheets as we can. We can be more disciplined around margin. And so yes, I think people -- our customers certainly recognize that we're reliable and there's a certainty of execution there. And so I think that loyalty shows up in our margins and in our production volumes.

So, you've been on about -- you've got sort of a commitment to a target of 11%. Just in the last couple of months since late May, the 10-year is off 70 bps. And if we get three or four cuts over the next six to nine months, is that not going to have to have some kind of impact on your rate? I mean, how are you thinking you guys thinking about it internally is in modeling? Like when the world -- when market rates change, are you going to have to respond? Or you can be -- like a credit card, credit cards are 18% to 21% regardless of where [Technical Difficulty] that funds are, right?

Yes. Good question. Yes. We lowered rates a couple of weeks ago when -- and so we monitor the bond markets. We took rates just down 0.25 point. So, we won't necessarily move lockstep with the markets because there is some volatility there. But we priced our debt mainly off of sort of somewhere between three to five year bonds depending on the weighted average life. And so that's kind of where we focus. We keep an eye on those shorter bond rates and we adjust for those base rate movements. So yes, I mean, I think if it continues, we'll follow the market. We will pass that along to our borrowers. And as long as we're maintaining our spread, we're happy.

Right. So, your securitizations obviously are fixed rate funds. The -- I guess the only benefit you would get on the liability side would assume your warehouse lines are floating, with I guess, on SOFR right?

Right. Correct.

Yes. So you will get some carry benefit there, obviously, although it's obviously offset a little bit by the lower coupons on the loans.

Probably, yes, right.

Great quarter. You keep beating estimates every quarter. So, I guess we're going to have to crank it up a little bit to catch up [Technical Difficulty].

Don't crank it up too much Steven.

Yes, I know. We won't, we won't. We just like it [Indiscernible] that's the good part of it. Congratulations, guys.

Thanks so much. Thank you, Steven.

[Operator Instructions] Your next question comes from Eric Hagen with BTIG. Please go ahead.

Hey guys, good afternoon. Hope you’re all doing well. Following up a little bit on the origination side. I mean from an operational and underwriting standpoint, do you feel like you're originating at capacity right now? Or how much more kind of operational leverage do you think you can potentially like extract and originate with your current cost structure right now?

Yes. Eric, thanks. We've spent a lot of money on technology. And in order to do 1,000 units a quarter, you've got to have that in place. So, I think we have excess capacity. I don't know, I'd say probably 10% to 20% more. As we go into the end of the year, we probably will increase some head count to accommodate hopefully, some growth. But it's at the margin and it's not too significant. So, I think we can add quite a bit more volume with not too much to the cost structure.

Yes. Okay, that’s very helpful. Thanks for giving some context there. I mean, what do you feel like is the all-in kind of ROE from originating and delivering into securitization with spreads at these levels, even if you have like a benchmark for the two deals that you did last quarter. And if we see securitization spreads tighten, I mean, what does that mean for your ROE? Is there a way to kind of benchmark that and sensitize that?

Yes. Yes. Good question. We think that the ROEs are north of 25% at these levels. If spreads tighten, we'll see the benefit of that over a multiyear period, obviously, because we're locking in fixed rate loans against fixed rate debt. So yes, if we see some tightening in the spreads, I think that could significantly boost ROE. On the go-forward deals, obviously, it's a blend of all of the transactions. But at the margin, I think new stuff is well north of 25%.

Really helpful. Thank you guys so much.

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

Yes. Thanks, everyone, for joining the call. We appreciate your support and we're going to just continue to execute on our plan and look forward to speaking to everyone next quarter. Thank you.

Thank you, everybody, for your time.