Velocity Financial, Inc. — Q3 2023 Form 10-Q
Reporting period: Three and nine months ended September 30, 2023. Amounts are U.S. dollars; financial statement amounts are generally in millions unless stated otherwise.
Business context and reporting period
Velocity originates and manages investor real estate loans, primarily secured by residential rental and commercial properties, and funds them mainly through securitizations and warehouse facilities. It also operates Century, a Ginnie Mae issuer and servicer providing FHA financing. Results are unaudited and interim results are not necessarily indicative of full-year performance.
Financial performance and position
- Q3 earnings: Interest income was $79.1 million, up 24.7% year over year; portfolio-related net interest income was $31.5 million, up 9.2%. Net income attributable to Velocity was $12.1 million versus $10.0 million; diluted EPS was $0.35 versus $0.29.
- Nine-month earnings: Interest income was $224.5 million versus $174.7 million. Net income attributable to Velocity was $34.9 million versus $23.7 million; diluted EPS was $1.02 versus $0.70.
- Other operating income: $17.4 million in Q3 versus $3.0 million a year earlier; $44.2 million for nine months versus $12.9 million. The 2023 period included fair-value gains on securitized debt of $9.7 million in Q3 and $15.1 million year to date. Fair-value loan changes were a $1.3 million Q3 loss but an $8.5 million nine-month gain.
- Costs and margins: Q3 operating expenses rose to $27.3 million from $13.2 million, including $4.9 million of securitization expenses and higher compensation. Portfolio-related net interest margin was 3.34%, down from 3.59% a year earlier; total-company margin was 2.90%, down from 3.09%. Portfolio cost of funds rose to 5.63% from 4.81%, while portfolio yield increased to 8.38% from 7.88%.
- Loans and credit: Portfolio UPB was $3.88 billion, up from $3.43 billion at September 2022. Weighted-average origination LTV was 68.0%. Nonperforming loans were $387.7 million, or 10.0% of the portfolio, versus $253.3 million, or 7.4%, a year earlier. The allowance for credit losses was $4.7 million; it excludes loans carried at fair value.
- Cash flow: For the first nine months, operating activities provided $22.7 million, investing activities used $360.8 million, and financing activities provided $323.2 million. Cash, cash equivalents and restricted cash decreased $15.0 million to $47.1 million. Cash paid for interest was $134.0 million.
- Debt and liquidity: At September 30, total securitized debt was $3.17 billion, warehouse and repurchase facilities were $215.2 million, and corporate secured financing was $210.8 million. The $215 million corporate term loan bears fixed interest at 7.125% and matures in March 2027. Management reported total liquidity of $654.0 million, including $29.4 million cash, $30.9 million available against unencumbered loans, and $593.6 million of available warehouse capacity. The company reported compliance with debt covenants.
- Equity: Total equity was $420.0 million at September 30, 2023, compared with $380.5 million at December 31, 2022.
Material changes versus comparable periods
- Q3 loan originations were $290.6 million, down from $457.3 million a year earlier; management attributed the decline to higher interest rates and a strategic reduction in originations amid economic uncertainty. Originations increased from $258.6 million in Q2 2023.
- Portfolio growth and higher loan yields lifted interest income, while higher market rates and a larger debt balance increased portfolio-related interest expense. Year-to-date portfolio-related net interest income increased only modestly, to $89.4 million from $87.8 million.
- Nonperforming loans rose as a share of UPB from 7.4% at September 2022 to 10.0% at September 2023; foreclosure balances increased from $192.4 million to $314.0 million.
- The company adopted fair-value-option accounting for newly originated mortgage loans beginning October 1, 2022, and elected it for certain securitized debt beginning January 1, 2023. These changes increased reported fair-value gains and caused more origination and securitization costs to be expensed as incurred, affecting period comparability.
- During Q3, Velocity completed two securitizations totaling approximately $316.3 million of securities issued, including its first securitization of short-term mortgage loans. It also began using cash-flow hedges; $155 million notional of swaps was outstanding at quarter-end.
Outlook, risks, contingencies and unusual items
- The filing provides no quantified earnings or origination guidance. Management said performance depends on loan demand, financing availability and cost, credit performance, and operating expenses.
- Management cited continued inflation, possible recession, real estate and corporate debt market stress, bank failures, geopolitical conflicts, and broader macroeconomic conditions as uncertainties that could affect results. Interest-rate volatility is identified as the primary market risk.
- Management used a severe-stress economic scenario in estimating the credit-loss allowance. COVID-19 forbearance loans totaled $177.0 million UPB, of which 23.3% was nonperforming or on nonaccrual at quarter-end, versus 19.7% at December 2022.
- The company received approximately $4.2 million of Employee Retention Credit funds in Q2 but deferred recognition of the net amount, approximately $3.6 million after specialist fees, pending resolution of uncertainty about the credit.
- Legal matters arise in the ordinary course; management does not expect pending or threatened matters to have a material adverse effect. Disclosure controls were assessed as effective, and no material change in internal control over financial reporting was reported.
Most important facts for investors to verify
- Whether the increase in nonperforming loans and foreclosures continues, and how recoveries, REO values and charge-offs develop.
- How much reported income depends on fair-value accounting gains, which can be volatile and are not equivalent to cash earnings.
- Whether portfolio margins can withstand higher warehouse and securitization funding costs, and whether securitization markets remain available.
- The composition and availability of the reported $654.0 million liquidity, including facility conditions, collateral requirements and covenant headroom.
- The status and ultimate recognition of the deferred Employee Retention Credit, and the performance of loans modified under the COVID-19 forbearance program.