Velocity Financial, Inc. — Q3 2020 Form 10-Q
Business and reporting period. Velocity originates and manages investor real-estate loans secured by residential rental and small commercial properties. This unaudited filing covers the quarter and nine months ended September 30, 2020; comparisons are with the corresponding 2019 periods unless noted. The company completed its IPO in January 2020 and converted from an LLC to a corporation.
Financial performance and position
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Interest income | $41.4m | $40.4m | $125.8m | $113.4m |
| Net interest income | $17.1m | $14.7m | $49.2m | $41.6m |
| Provision for loan losses | $1.6m | $0.3m | $4.7m | $0.9m |
| Operating expenses | $11.9m | $8.5m | $34.8m | $25.3m |
| Income before taxes | $5.0m | $5.7m | $11.4m | $17.3m |
| Net income | $3.5m | $3.9m | $8.2m | $12.1m |
- Q3 portfolio-related net interest margin was 3.77%, up from 3.54% in Q2 2020 but below 4.06% in Q3 2019. Total-company margin was 3.39%, versus 3.18% and 3.22%, respectively. Q3 portfolio yield was 8.21%.
- Q3 diluted EPS was $0.11 (basic $0.17). For the nine months, common shareholders’ loss was $40.8m, or $2.03 per share, despite $8.2m of net income, due principally to $49.0m in deemed preferred-stock dividends.
- At September 30, total assets were $2.127bn; cash and cash equivalents were $19.2m and restricted cash $7.8m. Total liabilities were $1.827bn. Net recorded debt comprised $1.671bn securitizations, $74.8m secured financing, and $19.5m warehouse/repurchase facilities. Stockholders’ equity was $209.8m, with $90.0m of Series A preferred stock presented separately as mezzanine equity.
- For the nine months, operating cash flow was $37.4m and investing cash flow was $73.3m, while financing used $111.2m. Cash, cash equivalents and restricted cash ended at $27.0m, down $0.5m from year-end 2019.
Changes and notable developments
- Net income fell year over year in both periods: Q3 by about 10% and nine-month net income by about 32%. Higher loan balances supported interest income, but the Q3 portfolio yield declined from 8.84% to 8.21%, primarily as COVID-19-related nonperforming loans increased. Nine-month interest income growth reflected a larger average portfolio.
- Credit costs rose: the allowance for credit losses was $5.7m at September 30 versus $2.1m a year earlier. The company adopted CECL on January 1, 2020, recording a $0.1m reduction to retained earnings at adoption.
- Operating expenses increased $3.4m in Q3 and $9.5m for the nine months. Management cited origination-related costs that were expensed during the production suspension rather than deferred, public-company costs, and a $0.6m severance charge in September.
- Loan originations and purchases were suspended in late March; no loans were originated or purchased in Q2. Originations resumed in September, when the company received over $220m of applications and closed $8.1m in loans. A workforce reduction of approximately 60 employees followed operational streamlining.
- In July, $214.4m of loans held for sale were transferred to held-for-investment status; the related $1.3m valuation allowance was reversed through earnings. The company also completed the $276m 2020-MC1 securitization and used proceeds to repay warehouse borrowings.
Outlook, risks and contingencies
- No formal earnings or financial guidance is provided. Management described continued uncertainty from COVID-19, including the duration of the pandemic, economic conditions, borrower performance, real-estate values, funding availability and securitization markets. The company was exploring financing alternatives for future originations.
- Loans granted COVID-19 forbearance totaled $411.2m UPB. Approximately $335.1m, or 81%, had subsequently been brought current; $308.3m, or 75%, had made their next scheduled payment. The company continued accruing interest on qualifying deferred loans and said it would continue assessing collectability and nonaccrual status.
- Nonperforming loans were $314.7m, or 15.8% of portfolio UPB, versus $102.0m, or 5.8%, at September 30, 2019. The reported Q3 amount included $34.9m of COVID-forbearance loans placed on nonaccrual. Management cited borrower equity and active servicing as mitigants, but loan resolutions were slower than in the prior-year quarter.
- The Series A preferred stock carries a $90m current recorded redemption value and a liquidation preference that can increase to $3,000 per share. Holders may require repurchase beginning in 2022, subject to debt-document restrictions; a change of control also triggers redemption provisions. Warrants cover approximately 3.0m common shares at exercise prices of $2.96 and $4.94.
- A securities class action filed in July 2020 alleges false or misleading statements and omissions in IPO offering materials; damages are unspecified. Management intends to defend the case and does not expect pending matters to have a material effect.
- Management reported a continuing material weakness in internal control over financial reporting relating to income-tax accounting. It said disclosure controls were effective at a reasonable-assurance level and the financial statements fairly presented the company’s position and results.
Important facts for investors to verify
- Whether the rise in nonperforming loans and the $411.2m forbearance exposure translate into additional delinquencies, charge-offs or allowance increases.
- Whether loan originations recover from the September restart, and the resulting effect on portfolio size, yield, expenses and earnings.
- The sustainability and cost of securitization and warehouse funding, including the preferred-stock repurchase terms and debt covenants.
- How much of reported earnings reflects temporary or unusual items, including the held-for-sale transfer, severance and IPO-related costs, and preferred deemed dividends.
- Progress remediating the tax-accounting material weakness and developments in the IPO-related class action.