Velocity Financial, Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020. Amounts are in U.S. dollars; financial statement amounts are in thousands unless otherwise noted. Velocity originates and manages investor real estate loans, primarily secured by residential rental and small commercial properties. It completed its IPO in January 2020 and converted from an LLC to a corporation.
Financial and operating performance
| Metric | Q1 2020 | Q1 2019 / comparator |
|---|---|---|
| Interest income | $44.6 million | $36.1 million; up 23.5% |
| Portfolio-related net interest income | $21.8 million | $17.1 million; up 27.6% |
| Net interest income | $15.4 million | $13.7 million |
| Provision for loan losses | $1.3 million | $0.3 million |
| Operating expenses | $12.1 million | $8.5 million; up 41.8% |
| Income before taxes | $3.7 million | $6.6 million |
| Net income | $2.6 million; $0.13 per share | $4.7 million; per-share figures not applicable before IPO |
| Portfolio yield / portfolio-related net interest margin | 8.57% / 4.18% | 8.89% / 4.20% in Q1 2019 |
Reported corporate debt interest expense was $6.3 million and included a one-time $3.5 million write-off of debt issuance costs and $0.3 million of prepayment penalties after the January repayment of $75.0 million of term-loan principal. Excluding these items, management reported Q1 net income of $5.2 million and pre-tax income of $7.5 million. Operating expense growth reflected business expansion and public-company costs, higher REO expenses, and IPO-related professional fees.
At March 31, total loans were $2.1 billion, including $1.9 billion held for investment and $223.1 million held for sale. The portfolio’s weighted-average origination LTV was 65.9%. Nonperforming held-for-investment loans were $151.1 million, or 7.9% of that portfolio, versus 5.3% a year earlier. The broader portfolio statistic reports nonperforming loans of $186.4 million, or 8.76% of total loans, under a different denominator.
The allowance for credit losses was $3.5 million, compared with $1.9 million at March 31, 2019. Q1 provision was $1.3 million; management attributed approximately $0.9 million of the year-over-year increase in the provision to COVID-19. The company adopted CECL on January 1, increasing the opening allowance by $137,000 and reducing retained earnings by $96,000 net of tax.
Cash, debt, and liquidity
Cash and cash equivalents were $7.6 million at quarter-end, down from $21.5 million at December 31; restricted cash was $4.5 million. Q1 operating cash flow was $1.4 million, investing cash outflow was $52.1 million, and financing cash inflow was $35.3 million. The resulting decrease in cash, cash equivalents, and restricted cash was $15.4 million.
Reported quarter-end debt, net of issuance costs, comprised $1.576 billion of securitizations, $297.5 million of warehouse repurchase facilities, and $74.4 million of secured corporate financing. Total liabilities were $2.007 billion and equity was $250.4 million. The company reported compliance with applicable debt covenants at March 31.
Changes, outlook, and material developments
- Loan originations rose 24.1% year over year to $247.6 million in Q1, but the company temporarily suspended originations in late March pending greater financial-market stability. Management expected originations to decline and stated that it would consider selective acquisitions, loan sales, and alternative financing.
- COVID-19 caused warehouse lenders to make approximately $14 million of margin calls in March. On April 6, the company amended both principal warehouse agreements: it paid $20 million toward obligations, agreed to payments of at least $3 million per month to each lender through August 3, accepted a 25-basis-point rate increase, and became subject to a minimum $7.5 million unrestricted-cash requirement. The amendments suspended mark-to-market features through August 3.
- On April 7, the company raised $45 million gross through a private placement of Series A convertible preferred stock and warrants; proceeds were intended partly to reduce warehouse debt and for general corporate purposes. The preferred stock has senior liquidation rights, potential cash repurchase obligations, and conversion terms that could materially dilute common shareholders. The warrants cover up to approximately 3.0 million shares.
- Management implemented a borrower forbearance program and reported that many employees, mostly in loan origination, were furloughed effective May 1. It said the financial impact and duration of COVID-19 could not be reasonably estimated.
- No specific earnings or financial guidance was provided. Management cited uncertainty around borrower payment performance, collateral values, origination activity, securitization access, warehouse funding, and the broader economy.
- A material weakness in internal control over financial reporting related to tax accounting remained as of March 31, pending further testing. Management said disclosure controls were effective at a reasonable assurance level. The company reported no material effect expected from pending litigation.
Most important facts for investors to verify
- Subsequent liquidity and funding: compliance with warehouse cash and repayment requirements, facility renewal or replacement, and use of the preferred-stock proceeds.
- COVID-19 credit trends: delinquencies, nonperforming loans, forbearance performance, collateral values, REO levels, and future CECL provisions.
- The effect of suspended originations and reduced staffing on loan growth, portfolio income, and operating costs.
- Preferred-stock repurchase and liquidation terms, conversion and warrant dilution, and associated shareholder voting and control rights.
- Progress in remediating the tax-accounting material weakness and the potential effect of any additional control deficiencies.