Good day and welcome to the Velocity Financial Inc. Q3 2020 Earnings Call. All participants are currently in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please also note today's event is being recorded.

I would like now to turn the conference call over to Chris Oltmann, Chief Accounting Officer. Please go ahead..

Thank you, Matt. Hello everyone and thank you for participating in Velocity Financial third quarter 2020 earnings call. 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 third quarter 2020 press release and the accompanying earnings presentation, which are available on our Investor Relations' website. I'd 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 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 annual and quarterly reports.

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 will also refer to certain non-GAAP measures on this call.

For reconciliations of these non-GAAP measures, you should refer to the press release and earnings presentation on our Investor Relations' website. Finally, today's call is being recorded and will be available on the Company's website later today. I will now turn the call over to Chris Farrar for opening remarks..

Thanks Chris. And thank you all for joining us today. We had a great quarter and I’m excited to host the call today. On our last earnings call, I outlined our plans to restart originations in the third quarter, and I'm very excited to report that we are completely operational.

Our new applications have returned to pre-COVID levels and the pipeline is expanding rapidly. The silver lining of our production pause was a chance to work on the nice to have projects that are often tough to accomplish when a company is growing.

We use the downtime to reevaluate our entire production platform and we made significant improvements to our process as well as our technology. These improvements will make us more efficient and more customer friendly going forward. We also restructured job functions and responsibilities, which resulted in a reduction of force at the end of September.

All these decisions are never easy. Our team is convinced they were necessary and beneficial to our future growth. In terms of the portfolio, we saw a stabilization of the non-performing loans and our asset managers continued to do an excellent job of resolving delinquent loans.

We continued to see strong recovery rates and the real estate markets are performing better than many had predicted. Additionally, it's important to note that we saw provision expense return to a normalized level in Q3 as the economy is performing above the adverse levels that we were assuming in our CECL model.

Looking forward, our team is working hard to create new relationships on the liability side of the balance sheet to eliminate mark-to-market risk and explore other debt structures to finance our growth during the fourth quarter and well into ‘21.

With regard to our people, most of us continue to work remotely, but we recently allowed certain of our team members to return to work in our physical locations. So -- as long as protocols are followed. I'm happy to report that we've had minimal issues by reopening our offices.

Fortunately, we're healthy, motivated, and happy to be serving our customers again. With that, we'll turn to our presentation materials. It's a relatively short and straightforward presentation today. So I'm going to just go through it top to bottom. Mark is on the call as well, and we'll both be available for Q&A.

Obviously from an earnings perspective, we're very pleased, net income up significantly as I mentioned in my opening remarks, driven largely by a return to just normalized provision expense. Portfolio NIM expanded as we saw fewer NPO loans and we're very pleased with the earnings result for the quarter.

In terms of production, we've already highlighted that we got restarted, but had tremendous response from the market. We saw near pre-COVID levels right out of the gate. And I'm very pleased to see how quickly our customers have been responding to our reopening.

In terms of resolutions, again, very strong for the quarter one three and a half on assets result. We expect that good performance to continue going forward and we see strong real estate markets as we continue to resolve these assets.

Another important milestone in the quarter about $335 million of loans that were in the forbearance program were actually brought current any amounts that were past due were tacked onto the end of the loan and they sit in a non-interest bearing account that will be recovered upon liquidation.

So that was a big slug of the forbearance loans that we had done in the prior quarter coming back to current status. So that was a very good improvement for us in the third quarter.

And from a financing and capital perspective, we're working on some new agreements right now that all have non mark-to-market provisions, as we've indicated in the past, that's our desire and our plans going forward. And we're making very good progress there and are looking forward to doing our next securitization in Q1.

Turning to Page 4 from just a core earnings perspective, core earnings were a touch higher as a result of the workforce reduction costs and the charge that we took there from restructuring. So, good results there and good book value growth as a result of the earnings in the quarter.

On 5, I mentioned the good asset resolution activity, we continue to see strong performance there and good resolutions as loans are paying off and borrowers are rectifying delinquent assets and are expected to continue that performance on a go forward basis.

Turning to 6, in terms of the portfolio, the one significant transaction in third quarter was our transfer of about $214 million of HFS loans to HFI, somewhat confusing, I think the GAAP requirements can sometimes distort the picture a little bit. Essentially, you'll see in our loan loss provision, a number of $1.6 million.

So, it might look at first blush that reserve provision is up for the quarter. But we had a offsetting low comp adjustment on the books already for those HFS loans, and so this is really just a reclassification under the GAAP requirements. And so, it actually ended up being $141,000 positive to net income rather, as a result of the reclass.

And so that transaction took place during the third quarter as a result of our securitization of those loans, but resulted in no real meaningful change to loan loss provision.

On 7, we talked about the production restart got really great response from our customers in Generate Velocity our broker portal had just under 400 new brokers sign up with us and in some of the technology enhancements, there were to find ways for folks to interact with us more seamlessly, make the website more friendly and just continually improve that broker and borrower experience.

And early returns are fantastic. We're getting much better application level and response level than we had even forecasted or hoped for. So, all those investments and enhancements, I think are going to continue to serve us well as we expand.

Turning to Page 8, net interest income, I mentioned the NIM expanded in the quarter, primarily driven by fewer new NPLs. And as we go forward, we hope that this will -- we can continue to improve on this NIM as we expand and grow the portfolio.

On 9, in terms of loan portfolio performance, you can see on the left hand side non-accrual loans, stabilized and ticked down slightly, our projection there and our expectation is that that we have in fact stabilized and over the next 12 to 18 months, we expect that to trend down as we resolve assets as they come off the balance sheet.

So we're pleased with what's going on there from an NPL perspective, especially in light of the positive resolutions. From a charge off perspective on the right hand side, this is the only kind of dig in the quarter. Unfortunately, we had one large loan that charged off. It was not a result of COVID. It was a large loan that we made about a year ago.

And it was kind of a Murphy's Law loan. Everything that could have gone wrong, did go wrong. We had some people internally that didn't follow a procedure and we let them go, we are pursuing this borrower legally for a deficiency judgment. And we're also actually pursuing the insurance from the appraiser.

I don't want to get too far in the leads, but if we need to in Q&A, we can. But the bigger point that I'm trying to make here is that it was kind of a one-off unfortunate situation. I think the last time something like this happened was five or six years ago.

And more importantly, it's not an indication of a larger trend or a large number of loans that were delinquent that we had to charge-off. It was just kind of a, an unfortunate event on our side, and we believe one time and not indicative of future performance.

On 10, just a little perspective on the CECL reserve, you can see running right around 29 basis points. We think we're very well preserved. I did mention that we use an adverse highly stressed forecast model for this CECL calculation.

And so far, the economy has been performing better than that those assumptions and those outcomes are predicted to be, we'll see how things go in the future. But we feel very good about our CECL reserve and the level of reserve vis-à-vis the portfolio. On 11, just talking about the future, we expect continued strong demand for our products.

We think there's some market dynamics there. We think there's some competitive dynamics there, but very pleased to see with see the response that we've received so far.

And in terms of performance, we're very hopeful that we've got our arms around the delinquency, and we'll continue to work that off, and we're seeing pockets of weakness across the country. But overall, in terms of real estate values there, they're holding up very well.

And we remain very optimistic on our ability to continue to liquidate delinquent assets. Lastly, in terms of profitability and growth, obviously very excited to be putting new assets on the balance sheet and believe that by Q2 next year, we'll be back to pre-COVID origination levels and driving higher net interest income into the profitability.

And then an important obviously, foundation in that strategy is to continue to expand our financing capacity. And we're working on that, and especially in the warehouse side of the balance sheet, just trying to make sure that we eliminate that mark to market risk.

So, I think we've put all the pieces in place to have a great year next year and continue to expand our growth plans. So, as I said, that was pretty, pretty quick presentation, pretty high level. And I think it's probably appropriate to just open it up for Q&A now for both, myself or Mark..

We will now begin the question-and-answer session. [Operator instructions] Our first question comes from Stephen Laws with Raymond James. Please go ahead..

Chris. I guess, first, let me talk about I think 53 million of production in October.

Is that kind of a good run rate as we think about November and December or is there seasonality or how do you think about that ramping? And kind of coupled with that, it seems like the focus recently it's been exclusively one to four rental, is that likely to continue for the foreseeable future? How do you think about the mix of the new loan production?.

Sure. So I think, it takes some time for applications to build and for your pipeline to build. So, I don't think the $63 million is the run rate, we do expect that to increase over the quarter. And there's a little bit of seasonality in Q1 kind of January-February. So, it could maybe level off or pull back a little in that Q1.

But we think, by the time we get to Q2, we'll be back to some more normalized levels that we were pre-COVID.

And then, in terms of the second part of your question, we tightened up on some of our small commercial guidelines, and intentionally wanted to have a little bit less exposure there just in light of obviously, all of the things going on in the economy.

So yes, I think on a go forward basis, we would expect a higher level of the one to four production than the small commercial little bit to new rate, but I think it's going to be weighted a little more towards the one to four..

Great, appreciate the color on that.

And kind of a follow up, given the trends we're seeing coming, coming out of COVID with migration shifts of you about half the portfolio is New York and California, have you seen a change in demand as of where the loan applications are coming from? Or have you seen anything interesting that that just shift the geographic concentration of the loan demands?.

Yes, not yet. Not yet. It's probably too new to rate still in the large MSA. As you know, we'd like to stay in the more liquid markets. So I would expect our originations to continue there. A lot of what we do is out in the suburbs, and has always been there.

So we're seeing a lot of demand there, but I don't think there's anything material yet we would highlight..

And then Mark, can you give us what goes into the other income line, $1.3 million for the quarter, nice pick up. It's been a little bit up and down this year. So you can give us an idea of what is in that line item? And how do we think about that, as we model forward..

Yes, what's in the other income line? Hi, Steve, what's in other income warning for Q3 as we talked about, we move the HFS loans about $214 million with UPB held for sale loans are held for sale category up and held for investment, because those loans were pledged in their securitization we did in July.

So what is Plexus accusation we're not able to sell it, we have to hold it. So GAAP requires you to move it up. So those loans are when they were held for sale held for sale loan, you find lower cost of market accounting.

So we had a really built up over time ever since those lows on the books and of last year, January, February of this year, we're still doing originations, we've built up a valuation allowance of about $1.3 million. That goes into other income as an expense as we are but I probably can't fix it.

When you're building up an allowance for a lower foster market valuation HFS loan it's a contra other income. So we built up a $1.3 million kind of write off to other income over time and we're seeing this allowance account.

Once we move those loans up into health reinvestment you have to reverse out that allowance that you had put in other income so we actually took a look a positive 1.3. It's the reversal of that 1.3 a while as we built up for a positive 1.3. It's kind of a non recurring big hit to other income because we reversed out for HFS allowance.

And when you move those loans up into HFI, now's as an HFI loan, they still have an allowance as well, but that's called loan officer.

So that's why you see different provision of about a 1.06 provision expense, but about 1.2 was that of 1.6 million is that 1.3 million and other income and 1.2 million are nothing to provision expenses just to re-class from other income, up into provision.

So, most all that 1.3 million that you see is just that one time reversal from the HFS, or other income is normally service..

All right, appreciate the color there..

And then in one other thing, one other thing I'll point out just in the presentation materials, the last slide, Slide 16 has a breakout that walks you through that whole entry so that kind of delineates it..

So there it is. I paused on 15 on my geographic question, so I haven't suffered, he points out. Lastly, and I'll drop off. But can you talk about financing costs went up due to where the markets were in June and July. It's good to get those deals done.

Can you talk about I know it's early for your target and 1Q securitization, but maybe, where do you see the market today? What type of I don't know if it's a margin you're thinking about or how you, one answer towards outlook for financing costs, but kind of how does a securitization market look today versus what you were able to execute in June or July?.

Yes. So, in talking to our investment bankers, we think it's significantly improved from that timeframe. We've got some pretty good data points to show that. I think in terms of where our spreads will be, we think they will be at least at where they were kind of pre-COVID. So, spread, and what I mean by spread is, I think, our interest earning spread.

In other words, the difference between the loan yield and our debt cost. So, I think the result of the Fed intervention, we believe will be able to be back to pre-COVID levels on a margin basis..

Our next question comes from Don Fandetti with Wells Fargo. Please go ahead..

Yes.

Can you talk a little bit about where yields are on new originations versus pre-COVID? And also, can you reconcile the share count of diluted shares, in terms of the press and warrants in there and will -- are they all in there, having gone through all the numbers in detail?.

Sure. Hi, Don. I'll take the first part, and I'll let Mark, cover the second one. On the first part, we're seeing coupons, about 75 basis points lower than where we were pre-COVID. But we think on the debt side, it's probably lower than that.

So again, from a spread perspective, we think will be at least that our normal spreads, if not wider, going forward..

Hey, Dan, this is Mark. In terms of the shares, we look like on a fully diluted basis. There's a little over 20 million common shares outstanding for Q3 on a fully diluted basis. That goes up to a little over 32 million shares because you have to take your average stock price for the quarter, average price was about $4.40.

So all the convertible preferred fall into the diluted category, which is like 11.7 million shares at $3.85 strike price. So that's below the $4.40. So that goes into the diluted. And then if you recall, there were -- the warrants were issued back in two tiers, two different strike prices, a $2.96 strike price and a $4.94.

Obviously, the $2.96 strike price will be considered dilutive because it's under the $4.40 average Velocity price. But the second tier the $4.90, the $4.91 strike price would not be dilutive because it’s still more than the $4.40 average.

So, what’s causing the extra $12 minute dilution is assuming that the preferred convertible converts and also the first tier of the warrants..

Our next question comes from Steve Delaney with JMP Securities. Please go ahead..

Thanks. Hello, everyone. A couple of mine have been taken.

But Chris, I was wondering, if you could just provide after the September reduction in force, if you could provide your current fulltime headcount today, versus where you stood at pre-COVID?.

Yes, we're reduced by 60 in terms of FTE..

Okay, approximately, how many does that put you with -- I don't have all figure..

I think we're 180-182..

Yes. Okay. All right, all right. Okay. Very good. And then, following up on Don's question on the coupons, I was going to ask the same thing. And if you're down 75, I'm looking at my rate sheet looks like the 10 years, probably down about 100. And credit spreads could be anywhere.

But it sounds like maybe you're able to get a slightly higher coupon relative to the 10 year today than maybe you did late last year, early this year. Does that I don't even know even think about it versus the 10 year because you what really matters is the MDS credit spread.

But the 10 years, I'll measure everything off the 10 year because, it's easy to find. You just look at your screen..

Yes. Yes. No, I think you're thinking about it the right way. And the other thing that doesn't immediately jump through is that we've reduced loan to values. So effectively, we're getting a higher coupon for a lower loan to value loan.

So, when you put those two together, yes, we're effectively getting at least the same spread, but probably a little bit wider than where we were pre-COVID..

Better risk adjusted, anyway.

And what are you generally quoting on LTV today? What do you - what are you trying to come in?.

I mean, we've reduced all of our commercial LTV by 5%..

So small balance..

Yes. It's a smaller percentage of the production. So overall, I don't think you'll see as big of a notch down in terms of weighted average LTV, because we're more skewed to the one to four for those of assets where risk adjusted..

Got it. Thank you for the comments..

Absolutely, thank you..

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

I just want to say thanks to everybody for joining the call. We appreciate your support and interest, and we're available, if you have a further follow up. Thank you..

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