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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
☒
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2022
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____to _____
Commission File: 001-39183
Velocity Financial, Inc.
(Exact Name of Registrant as Specified in Its Charter)
Delaware
46-0659719
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
30699 Russell Ranch Road, Suite 295
Westlake Village, California
91362
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code: (818) 532-3700
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading
Symbol
Name of each exchange
on which registered
Common stock, par value $0.01 per share
VEL
The New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by checkmark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒
If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. ☐
Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
As of June 30, 2022, the aggregate market value of voting and non-voting common stock held by non-affiliates of the registrant was $93.6 million, based on a closing price of $10.99.
As of March 1, 2023, the registrant had 32,624,787 shares of common stock, par value $0.01 per share, outstanding.
Documents Incorporated by Reference
Certain portions of our Definitive Proxy Statement pursuant to Regulation 14A of the Securities Exchange Act of 1934 in connection with our 2022 Annual Meeting of Shareholders are incorporated by reference into Part III of this Form 10-K.
Location of Exhibit Index
The index of exhibits is contained in Part IV of this Form 10-K on page 43.
Table of Contents
Page
PART I
1
Item 1.
Business
Item 1A.
Risk Factors
8
Item 1B.
Unresolved Staff Comments
Item 2.
Properties
Item 3.
Legal Proceedings
Item 4.
Mine Safety Disclosures
PART II
9
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6.
Selected Financial Data
10
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
12
Item 8.
Financial Statements and Supplementary Data
39
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A.
Controls and Procedures
Item 9B.
Other Information
40
PART III
41
Item 10.
Directors, Executive Officers and Corporate Governance
Item 11.
Executive Compensation
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13.
Certain Relationships and Related Transactions, and Director Independence
Item 14.
Principal Accounting Fees and Services
PART IV
42
Item 15.
Exhibits, Financial Statement Schedules
Item 16.
Form 10-K Summary
44
Signatures
98
Unless otherwise stated or the context otherwise indicates, references to “we,” “us,” “our,” “the Company,” “Velocity” and similar references refer to Velocity Financial, Inc. and its consolidated subsidiaries.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to the “safe harbor” created by those sections. All statements (other than statements of historical facts) in this Annual Report regarding the prospects of the industry and our prospects, plans, financial position and business strategy may constitute forward-looking statements. In addition, forward-looking statements generally can be identified by the use of forward-looking terminology such as “may,” “should,” “expect,” “intend,” “will,” “estimate,” “anticipate,” “plan,” “believe,” “predict,” “potential” and “continue” or the negatives of these terms or variations of them or similar terminology. Although we believe that the expectations reflected in these forward-looking statements are reasonable, we cannot provide any assurance that these expectations will prove to be correct. Such statements reflect the current views of our management with respect to our future. The following factors are among those that may cause actual results to differ materially from the forward-looking statements:
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You should not rely upon forward-looking statements as predictions of future events. The forward-looking statements in this Annual Report are based on our beliefs, assumptions and expectations of future performance, taking into account the information currently available to us. These statements are only predictions based upon our current expectations and projections about future events. Our actual results, level of activity, performance or achievements may differ materially from the results, level of activity, performance or achievements expressed or implied by our forward-looking statements. Other sections of this Annual Report may include additional factors that could adversely impact our business and financial performance. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time and it is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make in this Annual Report. Before investing in us, investors should be aware that the occurrence of certain events, some of which are described in this Annual Report, could have a material adverse effect on our business, results of operations and financial condition and could adversely affect your investment.
In addition, forward-looking statements reflect our beliefs and opinions on the relevant subject. These statements are based upon information available to us as of the date of this Annual Report, and while we believe such information forms a reasonable basis for such statements, such information may be limited or incomplete, and our statements should not be read to indicate that we have conducted an exhaustive inquiry into, or review of, all potentially available relevant information.
Undue reliance should not be placed on forward-looking statements, which are inherently uncertain. Except as may be required by law, we undertake no obligation to revise or update forward-looking statements to reflect events or circumstances that arise after the date of this Annual Report or to reflect the occurrence of unanticipated events.
Channels for Disclosure of Information
Investors and others should note that we may announce material information to the public through filings with the SEC, our website (www.velfinance.com), press releases, public conference calls and public webcasts. We use these channels to communicate with the public about us, our products, our services and other matters. We expect to use our website as a main form of communication of significant news. We encourage you to visit our website for additional information. The information on our website and disclosed through other channels is not incorporated by reference into this Annual Report and shall not be deemed to be incorporated by reference into any other filing under the Securities Act or the Exchange Act, except as expressly set forth by specific reference in such a filing.
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Available Information
The following documents and reports are available on our public website (www.velfinance.com):
The above documents that are submitted to the SEC will become available on our website as soon as reasonably practicable following such submission. In addition, you may also obtain a printed copy of any of the above documents or reports by sending a request to Investor Relations, to our corporate headquarters, or by calling 818-532-3708.
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Item 1. Business.
Our Company
We are a vertically integrated real estate finance company founded in 2004. We primarily originate and manage investor loans secured by 1-4 unit residential rental and commercial properties, which we refer to collectively as investor real estate loans. We originate loans nationwide across our extensive network of independent mortgage brokers which we have built and refined over the 18 years since our inception. Our objective is to be the preferred and one of the most recognized brands in our core market, particularly within our network of mortgage brokers.
We operate in a large and highly fragmented market with substantial demand for financing and limited supply of institutional financing alternatives. We have developed the highly-specialized skill set required to effectively compete in this market, which we believe has afforded us a durable business model capable of generating attractive risk-adjusted returns for our stockholders throughout various business cycles. We offer competitive pricing to our borrowers by pursuing low-cost financing strategies and by driving front-end process efficiencies through customized technology designed to control the cost of originating a loan. Furthermore, by originating loans through our efficient and scalable network of approved mortgage brokers, we are able to maintain a wide geographical presence and nimble operating infrastructure capable of reacting quickly to changing market environments.
We believe there is a substantial and durable market opportunity for investor real estate loans across 1-4 unit residential rental and small commercial properties, and that our institutionalized approach to serving these fragmented market segments underpins our long-term business strategy. Our growth to date has validated the need for scaled lenders with dedication to individual investors who own ten or fewer properties, a base which we believe represents the vast majority of activity across our core market. According to data from the U.S. Census Bureau, since 1965, the U.S. home rentership rate (the inverse of the home ownership rate) has averaged approximately 35%. According to an estimate published by Zillow in January 2021, the value of the U.S. residential housing sector is over $43 trillion. Ownership of residential properties for rent has historically been concentrated among smaller investors. According to data published by the Urban Institute in August and October 2017, an estimated 45% of single-family rental units (attached or detached) are owned by investors who own just one unit and an estimated 87% of investors own 10 or fewer units, while institutional ownership comprises less than 3% of the market.
Our primary growth strategy is predicated on organically continuing to serve and build loyalty within our network of mortgage brokers, while also expanding our network with new mortgage brokers through targeted marketing and improved brand awareness. We believe our reputation and 18-year history within our core market position us well to capture future growth opportunities. We continue to opportunistically pursue inorganic growth strategies such as acquiring portfolios of loans that meet our investment criteria and acquisitions of businesses that align with our strategic vision.
We make loans for business purposes only, which we believe limits our exposure to the regulatory constraints of consumer lending. We do not make consumer loans or lend on raw land.
On January 16, 2020, we converted from a limited liability company to a corporation incorporated under the law of the State of Delaware by filing a certificate of conversion with the Secretary of State of the State of Delaware and changed our name from Velocity Financial, LLC to Velocity Financial, Inc.
On December 28, 2021, the Company acquired an 80% ownership interest in Century Health & Housing Capital, LLC (“Century”). Century is a licensed Ginnie Mae issuer/servicer that provides government-insured Federal Housing Administration (FHA) mortgage financing for multifamily housing, senior housing and long-term care/assisted living facilities. Century originates loans through its borrower-direct origination channel and services the loans through its in-house servicing platform, which enables the formation of long-term relationships with its clients and drives strong portfolio retention. Century earns origination fees and servicing fees from the mortgage servicing rights on its servicing portfolio.
Market Uncertainties in 2023
Our operational and financial performance will depend on the certain market developments, including any lingering impact of the COVID-19 pandemic, the Russia/Ukraine war, a global recession, heightened stress in the commercial real estate and corporate debt markets, and macroeconomic conditions and market fundamentals, which can all affect each of these factors and potentially impact our business performance.
Our Competitive Advantages
We believe that the following competitive advantages enhance our ability to execute our business strategy and position us well for future growth:
Established Franchise with Strong Brand Recognition
We believe our reputation and deep history within the real estate lending community position us as a preferred lender for mortgage brokers. We have been originating and acquiring loans in our core market since our inception in 2004, making us a recognizable brand with a proven ability to execute. Additionally, we have successfully executed twenty-five securitizations of our investor real estate loans, issuing $5.4 billion in principal amount of securities between 2011 and the year ended December 31, 2022. We have a keen understanding of this securitization market, including complicated structural issues, investor expectations and rating agency requirements. We executed our twentieth through twenty-fifth securitizations in 2022. We believe this demonstrates that we have a strong reputation with investors in the securitization market, which enables us to maintain efficient access to debt capital that ultimately improves our ability to offer competitive pricing to our borrowers.
Customized Technology and Proprietary Data Analytics
We have invested in and customized automated systems to support our use of data analytics which drives our lending process. We believe the investor real estate lending market requires a highly-specialized skill set and infrastructure. To effectively compete and execute on a sustainable long-term business strategy, lenders must control the cost to originate and manage loans without sacrificing credit quality. We believe our investment in technology and use of data analytics helps us achieve these critical objectives and positions our business for sustainable, long-term growth.
We apply the same asset-driven underwriting process to all of the loans in our portfolio, regardless of whether we originate or acquire these loans. Our credit and underwriting philosophy encompasses individual borrower and property due diligence, taking into consideration several factors. Our access to 18 years of proprietary data allows us to perform analytics that inform our lending decisions efficiently and effectively, which we believe is a strong competitive advantage.
Large In-Place Portfolio with Attractive, Long-Term Financing
We believe our in-place portfolio provides a significant and stable income stream for us to invest in future earnings growth. Our loans are structured to provide interest rate protection. The majority of our loans are fixed-rate loans and a smaller portion of our loans are floating after an initial fixed-rate period, subject to a floor equal to the starting fixed rate. The loans are mainly financed with long-term fixed-rate debt, resulting in a spread that could increase over time, but not decrease. As a result, our in-place portfolio generally benefits from rising interest rates. We generated $112.6 million in portfolio related net interest income for the year ended December 31, 2022, representing a 3.64% net interest margin during the year ended December 31, 2022.
Our In-House Asset Management Results in Successful Loss Mitigation
Direct management of individual loans is critical to avoiding or minimizing credit losses and we work with our third-party primary servicers with whom we have developed strong relationships to emphasize disciplined loan monitoring and early contact with delinquent borrowers to resolve delinquencies. We have a dedicated asset management team that, augmented with primary servicing from our loan servicers, focuses exclusively on resolving delinquent loans. Our hands-on approach enables us to generally preserve the value of our assets and helps us to minimize losses. We believe this expertise, combined with our outsourced servicing relationships, gives us a distinct competitive advantage.
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Our Experienced Management Team
Led by co-founder and Chief Executive Officer Christopher Farrar, our management team averages more than 25 years of experience in the financial services and real estate lending industries, including extensive experience in commercial and residential lending, structured finance and capital markets. We have successfully navigated both positive and negative economic cycles and retained our core team of experienced professionals in appraisal, underwriting, processing and production, while bolstering our finance and asset management team with professionals possessing extensive experience in financial reporting and real estate management. We believe our in-depth knowledge of our core market provides a distinct competitive advantage.
Our Growth Strategy
The market for investor real estate loans is large and highly fragmented. We have built a dedicated and scalable national lending platform focused specifically on serving this market and believe our capabilities position us well to maintain our reputation as a preferred lender in this market. Our organic growth strategy is predicated on further penetrating our existing network of mortgage brokers and expanding our network with new mortgage brokers. A key element of our implementation of this strategy is the growth and development of our team of account executives, as well as targeted marketing initiatives. We will continue to supplement the extension of our broker network with the development of new products to support the evolving needs of borrowers in our core market.
We continue to opportunistically pursue inorganic growth strategies such as acquiring portfolios of loans that meet our investment criteria and acquisitions of businesses that align with our strategic vision.
Further Penetrate Our Existing Mortgage Broker Network
We strive to be the preferred lender within our network of approved mortgage brokers. We have developed a strong reputation in the market for high quality execution and timely closing, which we believe are the most important qualities our mortgage brokers value in selecting a lender. There is significant opportunity for us to further penetrate the approximately 3,137 mortgage brokers with whom we have done business over the last five years. Approximately 64% of loan originators originated five or fewer loans with us during the year ended December 31, 2022. We believe this presents a compelling opportunity for us to capture incremental volume from our existing broker network.
Expand Our Network with New Mortgage Brokers
We believe that our targeted sales effort, combined with consistent high-quality execution, positions us well to continue adding to the network of mortgage brokers that rely on us to serve their borrower clients.
Despite the adverse macroeconomic conditions caused by inflation and rising interest rates, we funded 4,135 loans sourced by 1,269 different mortgage brokers during the year ended December 31, 2022. We believe that represents a small portion of the mortgage originators in the United States, which consisted of approximately 939,000 state-licensed mortgage originators by the end of 2021 according to the Nationwide Multistate Licensing System. The size of the mortgage broker market presents an attractive opportunity for us to capture significant growth with very small increases in the share of mortgage brokers that recognize our platform capabilities and utilize us as a preferred lender in our core market.
Develop New Products
Our primary products are a 30-year amortizing term loan with a three-year fixed-rate period which floats at a spread to the prime rate thereafter subject to a floor equal to the starting fixed rate, and a 30-year fixed-rate amortizing term loan. These loans comprised 92.6% of our loan originations during the year ended December 31, 2022. These products are used by borrowers to finance stabilized long-term real estate investments. We believe these products have strong receptivity in our market, as evidenced by our success in growing loan originations over time. Since our inception, we have continued to expand our product offering in response to developing market opportunities and the evolving financing needs of our broker network. For example, in 2013, in response to the increased demand for rental properties, we moved aggressively into the market for 1-4 unit residential rental loans, which comprised 52.7% of our held for investment loan portfolio as of December 31, 2022.
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In March 2017, we began originating short-term, interest-only loans to be used for acquiring, repositioning or improving the quality of 1-4 unit residential investment properties. This product typically serves as an interim solution for borrowers and/or properties that do not meet the investment criteria of our primary 30-year product. The short-term, interest-only loan allows borrowers to address any qualifying issues with their credit and/or the underlying property before bridging into a longer-term loan. In June 2018, we added a second short-term, interest-only loan product which allows borrower draws for rehabbing residential rental property. Historically, we have aggregated and sold most of these short-term, interest-only loans at a premium to par to institutional investors, which has generated attractive income for us with limited capital while also allowing us to establish an underwriting track record and monitor the performance of these loans. In December 2021 we added a new HUD multi-family and healthcare loan product offering with our acquisition of a majority interest in Century.
Opportunistically Acquire Portfolios of Loan and Acquire Strategically-Aligned Businesses
We continually assess opportunities to acquire portfolios of loans that meet our investment criteria. Over the past 18 years, our management team has developed relationships with many financial institutions and intermediaries that have been active investor real estate loan originators or investors. We believe that our experience, reputation, and ability to effectively manage these loans makes us an attractive buyer for this asset class, and we are regularly asked to review pools of loans available for purchase. In our experience, portfolio acquisition opportunities have generally been more attractive and plentiful during market conditions when origination opportunities are less favorable. Accordingly, we believe our acquisition strategy not only augments our origination business, but also provides a counter-cyclical benefit to our overall business.
Our Portfolio
Loans Held for Investment
Our typical investor real estate loan is secured by a first lien on the underlying property with the added protection of a personal guarantee and, based on the loans in our portfolio as of December 31, 2022, has an average balance of approximately $395,000. As of December 31, 2022, our portfolio of loans held for investment totaled $3.5 billion of unpaid principal balance, or UPB, on properties in 45 states and the District of Columbia. Of the 8,893 loans held for investment as of December 31, 2022, 98.9% of the portfolio, as measured by UPB, was attributable to our loan origination business, while the remaining 1.1% of the portfolio, or 68 loans, totaling $40.1 million in UPB, were related to acquisitions. During the years ended December 31, 2022 and 2021, we originated 4,135 and 3,105 loans to be held for investment totaling $1.5 billion and $1.3 billion, respectively.
As of December 31, 2022, 85.7% of our loans held for investment, as measured by UPB, were fully-amortizing over 30 years. The principal amount of a fully-amortizing loan is repaid ratably over the term of the loan, as compared to a balloon loan where all, or a substantial portion of, the original loan amount is due in a single payment at the maturity date. We believe that fully-amortizing loans face a lower risk of default than balloon loans, as the final payment due under the balloon loan may require the borrower to refinance or sell the property.
We target investor real estate loans with loan-to-value ratios, or LTVs, between 60% and 75% at origination as we believe that borrower equity of 25% to 40% provides significant protection against credit losses. As of December 31, 2022, our loans held for investment had a weighted average LTV at origination of 68.2%. Additionally, as of December 31, 2022, borrowers personally guaranteed 100.0% of the loans in our held for investment portfolio and had a weighted average credit score at origination of 719, excluding the 1.3% of loans for which a credit score is not available.
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The following charts illustrate the composition of our loans held for investment as of December 31, 2022:
(*) Percentages may not sum to 100% due to rounding.
We typically do not lend on any property located in a city with a population less than 25,000 and outside a 25-mile radius of a city with a population in excess of 100,000. We generally prefer to lend in larger metropolitan statistical areas.
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Our Financing Strategy
We typically finance our new loan originations using warehouse facilities. Once we have originated between approximately $175 million and $400 million in new loans, we securitize the loans through a real estate mortgage investment conduit, or REMIC, structure and issue the bonds to third parties through individual trust vehicles. All our securitizations are issued as private placements pursuant to Rule 144A under the Securities Act and utilize a REMIC structure except for the 2020 MC1 and 2022 MC1 transactions which were issued as one class of bonds treated as debt for tax purposes. The REMIC transactions can create significant U.S. GAAP versus tax differences. The U.S. GAAP treatment considers each REMIC as a variable interest entity that is required to be consolidated in our financial statements, accounting for the securitization as a secured borrowing. Under IRS rules, the REMICs require sale treatment where we are required to either recognize taxable income or loss to the extent the fair market value of the REMICs is greater than or less than our cost basis, the payment of which creates either a deferred tax asset or a deferred tax liability. We are the sole beneficial interest holder of each of the trusts, through our wholly-owned subsidiaries. Proceeds from the issuance of the securities are then used to pay down the balances on our warehouse facilities. As of December 31, 2022, we had successfully executed twenty-five securitizations of our investor real estate loans, issuing $5.4 billion in principal amount of securities. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources” for additional information about our warehouse repurchase facilities and securitizations.
In February 2021, we entered into a five-year $175.0 million syndicated corporate debt agreement (“2021 Term Loan”). The 2021 Term Loan bore interest at a rate equal to one-month LIBOR plus 8.00%, with a 1.00% LIBOR floor, and was set to mature in February 2026. In March 2022, we entered into a five-year $215.0 million syndicated corporate debt agreement (“the 2022 Term Loan”). The 2022 Term Loan bears interest at a fixed rate of 7.125% and matures on March 15, 2027. A portion of the net proceeds from the 2022 Term Loan was used to redeem all the amounts owed pursuant to the 2021 Term Loan.
Depending on market conditions, we may increase leverage on our investments with an amount of debt we deem prudent, subject to applicable risk retention rules. Our decision to use leverage to finance our assets will be based on our assessment of a variety of factors, including, among others, the anticipated liquidity and price volatility of the assets in our investment portfolio, the potential for losses and extension risk in our portfolio, the availability of credit at favorable prices, the credit quality of our assets and the outlook for our borrowing costs relative to the interest income earned on our assets and, where applicable, regulatory requirements with respect to securitizations.
Going forward, our financing sources may include borrowings in the form of additional bank credit facilities (including term loans and revolving facilities), additional warehouse repurchase facilities, structured financing arrangements, future securitizations and public and private equity and debt issuances, in addition to transaction or asset-specific funding arrangements. We intend to use leverage primarily to finance our portfolio and not for speculating on changes in the level of interest rates. We are not required to employ specific debt levels, and we believe the appropriate leverage for the particular assets we may finance depends on the factors discussed above.
We expect to continue financing our loan portfolio with equity and our financing arrangements, including warehouse lines for short-term financing and securitizations for long-term financing. We believe using securitizations to finance our investor real estate loans fits well with our strategy of holding interest-earning assets over the long-term to earn a spread. This type of financing structure more closely matches the asset duration with the duration of the financing.
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Competition
The business of financing investor real estate loans is competitive. We compete with specialty finance companies, regional and community banks and thrifts, public and private entities, institutional investors, mortgage bankers, insurance companies, investment banking firms, and other financial institutions, and we expect that additional competitors may be organized or otherwise enter our core market in the future. We believe we compete favorably through diversified borrower access driven by our extensive network of mortgage brokers and by emphasizing a high level of real estate and financial expertise, customer service, and flexibility in structuring transactions, as well as by attracting and retaining experienced managerial and marketing personnel. However, we may not be able to achieve our business goals or expectations due to the competitive risks that we face. Some of our competitors may be better positioned to market their services and financing programs because of their ability to offer more favorable rates and terms and other services. Such rates may be impacted by the competitor’s size, cost of funds, and access to funding sources that are not available to us.
Government Regulation
Certain states in which we conduct business require approval, registration or licensing. Typically, the mortgage broker that originates the loan that we make, fund or acquire is licensed or exempt from licensing in the state where the loan is made. We also hold a Federal Housing Administration, or FHA, Title II approval from the Department of Housing and Urban Development, which permits us to make certain government-insured loans. With the acquisition of Century, we are now a licensed Ginnie Mae (GNMA) issuer/servicer that provides government-insured Federal Housing Administration (FHA) mortgage financing for multifamily housing, senior housing and long-term care/assisted living facilities. As a licensed Ginnie Mae issuer/servicer, we are subject to GNMA's regulations.
We may be required to obtain licenses to originate investor real estate loans in the various additional jurisdictions in which we conduct our business or to acquire investor real estate loans. If we are required to obtain additional licenses to originate or acquire investor real estate loans, the process may be costly and could take several months. There is no assurance that we will obtain the licenses required or that we will not experience significant delays in seeking these licenses. Furthermore, we may be subject to various reporting and other requirements to maintain these licenses, and there is no assurance that we may satisfy those requirements. Our failure to maintain or obtain licenses may restrict our investment options and could harm our business.
Human Capital Resources
As of December 31, 2022, we had a total of 194 employees, a decrease of 10% from the prior year. None of our employees are represented by a labor union. The decrease in our employees was a result of our planned reduction in loan origination due to the dislocation in the current macroeconomic environment.
A driving force in our ability to generate revenue comes from the work of our Account Executives, or AEs. Our AEs generate business for us through their relationships with third-party brokers. Our ability to retain and attract AEs is essential to the growth of our business. A significant number of our employees are AEs, representing 30% of our workforce at year-end.
Our employment strategy is to create a culture that allows us to attract and retain the very best talent in our industry, provide competitive pay and benefits, and to ensure a healthy work environment comprised of an employee base that is considerate, collaborative, productive and driven. We are committed to building a great place to work for all of our employees. We provide an hourly wage or salary to our employees as well as the potential for discretionary bonuses. AEs are also eligible to receive additional quarterly bonuses based partially on the AEs revenue-generating results during the quarter.
While we have not adopted any diversity quotas, 65% of our employees are men and 35% are women.
We are committed to the health, safety, and wellness of our employees. In response to the pandemic, we implemented precautionary policies and significant operational changes to protect and support our employees, including remote working. As of December 31, 2022, substantially all our employees have been able, and continue, to work remotely.
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We and our employees are also committed to improving the communities in which we work and live. Through our charitable donations and Velocity Volunteers, we pick local charitable causes and projects to support and encourage our employees to donate their time and needed materials.
Our Corporate Information and History
Velocity Financial, Inc. is a corporation incorporated under the law of the State of Delaware.
On January 22, 2020, we completed the initial public offering (“IPO”) of our common stock, par value $0.01 per share (our “common stock”). Shares of our common stock trade on the New York Stock Exchange under the symbol “VEL.”
Our offices are located at 30699 Russell Ranch Road, Suite 295, Westlake Village, California 91362, and the telephone number of our offices is (818) 532-3700. Our internet address is www.velfinance.com. Our internet website and the information contained therein or connected to or linked from our internet web site are not incorporated information and do not constitute a part of this Annual Report or any amendment thereto.
Item 1A. Risk Factors.
Intentionally omitted pursuant to smaller reporting company reduced disclosure requirements.
Item 1B. Unresolved Staff Comments.
None.
Item 2. Properties.
Our corporate headquarters are located in leased space at 30699 Russell Ranch Road, Suite 295, Westlake Village, CA 91362.
Item 3. Legal Proceedings.
From time to time, in the ordinary course of business, we are involved in various judicial, regulatory or administrative claims, proceedings and investigations. These proceedings and actions may include, among other things, allegations of violation of banking and other applicable regulations, competition law, labor laws and consumer protection laws, as well as claims or litigation relating to intellectual property, securities, breach of contract and tort. We intend to defend ourselves vigorously against any pending or future judicial, regulatory or administrative claims or proceedings. Although occasional adverse decisions or settlements may occur, our management does not believe that the final disposition of any currently pending or threatened matter will have a material adverse effect on our business, financial position, results of operations or cash flows.
Item 4. Mine Safety Disclosures.
Not applicable.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information
Our common stock is listed on The New York Stock Exchange under the symbol VEL.
As of February 16, 2023, there were approximately 1,500 beneficial holders of our common stock.
Dividend Policy
We have not declared or paid cash dividends to date on our common stock and we do not intend to pay dividends for the foreseeable future. Any future determination to declare dividends will be made at the discretion of our board of directors and will depend on our financial condition, operating results, capital requirements, general business conditions, limitations in our debt instruments and other factors that our board of directors may deem relevant.
Issuer Purchases of Equity Securities
Unregistered Sales of Equity Securities and Use of Proceeds
No common stock purchases were made by us during the three months ended December 31, 2022.
Item 6. Selected Financial Data.
The consolidated statements of income information for the years ended December 31, 2022, 2021, 2020, 2019 and 2018 and the consolidated balance sheets information presented below have been derived from our audited consolidated financial statements. The information presented below is only a summary and does not provide all of the information contained in our historical consolidated financial statements, including the related notes. You should read it in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our consolidated financial statements, including the related notes, included elsewhere in this Annual Report on Form 10-K. Our historical results are not necessarily indicative of the results that may be expected for any other period in the future.
Year Ended December 31,
Consolidated Statements of Income Information
2022
2021
2020
2019
2018
(in thousands, except per share amounts)
Interest income
$
240,343
181,968
167,322
157,531
124,722
Interest expense — portfolio related
127,723
85,386
87,826
83,903
62,597
Net interest income — portfolio related
112,620
96,582
79,496
73,628
62,125
Interest expense — corporate debt
29,472
20,609
12,049
14,618
13,322
Net interest income
83,148
75,973
67,447
59,010
48,803
Provision for (reversal of) loan losses
1,152
(292
)
5,068
1,139
201
Net interest income after provision for loan losses
81,996
76,265
62,379
57,871
48,602
Other operating income
Gain on disposition of loans
7,107
7,892
7,576
4,410
1,200
Unrealized gain (loss) on fair value loans
8,265
29
442
(9
241
Other income (expense)
6,853
267
(1,698
(1,752
1,366
Total other operating income
22,225
8,188
6,320
2,649
2,807
Operating expenses
Compensation and employee benefits
30,458
19,190
20,731
15,511
15,105
Rent and occupancy
1,748
1,769
1,743
1,531
1,320
Loan servicing
12,298
8,282
7,802
7,396
6,009
Professional fees
4,179
3,781
4,238
2,056
3,040
Real estate owned, net
(70
3,150
2,656
2,647
1,373
Other operating expenses
11,056
8,488
8,400
5,981
5,313
Total operating expenses
59,669
44,660
45,570
35,122
32,160
Income before income taxes
44,552
39,793
23,129
25,398
19,249
Income tax expense
12,033
10,569
5,352
8,106
11,618
Net income
32,519
29,224
17,777
17,292
7,631
Net income attributable to noncontrolling interest
308
—
Net income attributable to Velocity Financial, Inc.
32,211
Less undistributed earnings attributable to participating securities
491
8,589
NA
Less deemed dividends on preferred stock
48,955
Net income (loss) allocated to common shareholders
31,720
20,635
(31,178
Earnings (loss) per common share
Basic
0.99
0.90
(1.55
Diluted
0.94
0.86
Weighted average common shares outstanding
31,913
22,813
20,087
34,131
33,982
NA - Not applicable prior to the Company's IPO on January 17, 2020.
December 31,
Consolidated Balance Sheets Information
(in thousands)
Assets
Cash and cash equivalents
45,248
35,965
13,273
21,465
15,008
Restricted cash
16,808
11,639
7,020
6,087
1,669
Loans held for sale, net
87,908
13,106
214,467
78,446
Loans held for investment, net
3,272,390
2,527,564
1,948,089
1,863,360
1,567,408
Loans held for investment at fair value
276,095
1,359
1,539
2,960
3,463
Total loans, net
3,548,485
2,616,831
1,962,734
2,080,787
1,649,317
Accrued interest receivables
20,463
13,159
11,373
13,295
10,096
Receivables due from servicers
65,644
74,330
71,044
49,659
40,473
Other receivables
1,075
1,812
4,085
4,778
974
13,325
17,557
15,767
13,068
7,167
Property and equipment, net
3,356
3,830
4,145
4,680
5,535
Deferred tax asset
5,033
16,604
6,654
8,280
517
Mortgage servicing rights, at fair value
9,238
7,152
Goodwill
6,775
Other assets
13,525
6,824
6,779
12,667
4,479
Total assets
3,748,975
2,812,478
2,102,874
2,214,766
1,735,235
Liabilities and Equity / Members' Equity
Accounts payable and accrued expenses
91,525
92,195
63,361
56,146
26,797
Secured financing, net
209,846
162,845
74,982
145,599
127,040
Securitizations, net
2,736,290
1,911,879
1,579,019
1,438,629
1,202,202
Warehouse repurchase facilities, net
330,814
301,069
75,923
421,548
215,931
Total liabilities
3,368,475
2,467,988
1,793,285
2,061,922
1,571,970
Preferred stock/Class C preferred units
90,000
26,465
Shareholders'/Members’ equity
376,811
341,109
219,589
152,844
136,800
Noncontrolling interest in subsidiary
3,689
3,381
Total liabilities and equity / members’ equity
11
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of our financial condition and results of operations should be read together with “Item 6. Selected Financial Data” and the consolidated financial statements and related notes and the other financial information included elsewhere in this Annual Report. This discussion contains forward-looking statements, as described above under the heading “Forward-Looking Statements” that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and elsewhere in this Annual Report.
We are a vertically integrated real estate finance company founded in 2004. We primarily originate and manage investor loans secured by 1-4 unit residential rental and commercial properties, which we refer to collectively as investor real estate loans.
Our primary source of revenue is interest income earned on our loan portfolio. Our typical loan is secured by a first lien on the underlying property with a personal guarantee and, based on all loans in our portfolio as of December 31, 2022, has an average balance of approximately $395,000. As of December 31, 2022, our loan portfolio totaled $3.5 billion of UPB on properties in 45 states and the District of Columbia. The total portfolio had a weighted average loan-to-value ratio, or LTV at origination, of 68.2%, and was concentrated in 1-4 unit residential rental loans, which we refer to as investor 1-4 loans, representing 52.7% of the UPB. During the year ended December 31, 2022, the yield on our total portfolio was 7.77%.
We fund our portfolio primarily through a combination of committed and uncommitted secured warehouse facilities, securitizations, corporate debt and equity. The securitization market is our primary source of long-term financing. We have successfully executed 25 securitizations, issuing $5.4 billion in principal amount of securities from May 2011 through December 2022.
One of our core profitably measurements is our portfolio related net interest margin, which measures the difference between interest income earned on our loan portfolio and interest expense paid on our portfolio-related debt, relative to the amount of loans outstanding over the period. Our portfolio-related debt consists of our warehouse facilities and securitizations and excludes our corporate debt. For the year ended December 31, 2022, our portfolio related net interest margin was 3.64%. We generate profits to the extent that our portfolio related net interest income exceeds our interest expense on corporate debt, provision for loan losses and operating expenses. For the year ended December 31, 2022, including net income attributable to noncontrolling interest, we generated income before income taxes and net income of $44.6 million and $32.5 million, respectively, and earned a pre-tax return on equity and return on equity of 12.2% and 8.9%, respectively.
Items Affecting Comparability of Results
Due to a number of factors, our historical financial results may not be comparable, either from period to period, or to our financial results in future periods. We have summarized the key factors affecting the comparability of our financial results below.
Income Taxes
Our REMIC transactions can create significant U.S. GAAP versus tax differences. The U.S. GAAP treatment considers each REMIC as a variable interest entity that is required to be consolidated in our financial statements, accounting for the securitization as a secured borrowing. Under IRS rules, the REMICs require sale treatment and we are required to either recognize taxable income or loss to the extent the fair market value of the REMICs is greater than or less than our cost basis, the payment of which creates either a deferred tax asset or deferred tax liability.
We will continue to recognize deferred tax assets and liabilities for future tax consequences attributable to differences between the financial statement carrying amounts of our existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using the tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the statements of operations in the period that included the enactment date, as applicable.
Interest Expense on Corporate Debt
The 2021 Term Loan was a five-year $175.0 million syndicated corporate debt agreement. We incurred $20.6 million of interest expense related to our corporate debt during the year ended December 31, 2021.
In March 2022, we entered into a five-year $215.0 million syndicated corporate debt agreement (“the 2022 Term Loan”). A portion of the net proceeds from the 2022 Term Loan was used to redeem all the amounts owed pursuant to the 2021 Term Loan. The remaining portion of the net proceeds from the 2022 Term Loan is used for loan originations and general corporate purposes. We incurred $29.5 million of interest expense related to our corporate debt during the year ended December 31, 2022.
Fair Value Option Accounting
We have made an election to apply the fair value option ("FVO") accounting to all our originated mortgage loans on a go-forward basis beginning October 1, 2022. The fair value option loans will be presented on a separate line item in the consolidated balance sheet. We will not record a CECL loan loss reserve on fair value option loans.
We utilize a third-party model to estimate the fair value of the FVO loan portfolio in accordance with ASC 820. We use a discounted cash flow methodology, that forecasts contractual cash flows, adjusting for projected prepayments and defaults, followed by discounting these cash flows back to a present value, using a reasonable discount rate.
Recent Developments
Securitizations
In January 2023, we completed the securitization of $240.3 million of investor real estate loans, measured by UPB.
Continued Market Uncertainties
Our operational and financial performance will depend on certain market developments, including any lingering impact of the COVID-19 pandemic, the Russia/Ukraine war, a global recession, heightened stress in the commercial real estate and corporate debt markets, and macroeconomic conditions and market fundamentals, which can all affect each of these factors and potentially impact our business performance.
Critical Accounting Estimates and Significant Accounting Policies
Our consolidated financial statements are prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States and follow general practices within the financial services industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. The most significant accounting policies we follow are summarized in “Note 2 — Basis of Presentation and Summary of Significant Accounting Policies.”
Management considers an accounting estimate to be critical to reported financial results if (1) the accounting estimates require management to make assumptions about matters that are highly uncertain, and (2) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on our consolidated financial statements, results of operations, or liquidity. Our critical accounting estimates are summarized below.
13
Allowance for Loan Losses
For our loans held for investment where we have not elected fair value option ("FVO") accounting, we calculate an allowance for loan losses. Under the current expected credit loss ("CECL") methodology, the allowance for credit losses is measured on a collective (pool) basis when similar risk characteristics exist. We identified the following portfolio segments based on risk characteristics of the loans in its loan portfolio (pool):
We determined the collectability of our loans by evaluating certain risk characteristics. The segmentation of our loan portfolio was determined based on analyses of our loan portfolio performance over the past nine years. Based on analyses of the loan portfolio’s historical performance, we concluded that loan purpose and product types are the most significant risk factors in determining our expectation of future loan losses. Loan purpose considers whether a borrower is acquiring the property or refinancing an existing property. Our historical experience shows that refinance loans have higher loss rates than loans for property acquisitions. Product type includes residential 1-4 unit property and traditional commercial property. Our historical experience shows that traditional commercial property loans have higher loss rates than residential 1-4 unit property. Short Term loans have a maturity of one to two years from origination. Long term loans have a maturity of up to 30 years from origination.
We estimate the allowance for loan losses using relevant available information, from internal and external sources, relating to historical performance, current conditions, and reasonable and supportable macroeconomic forecasts. Historical credit loss experience provides the basis for the estimation of expected credit losses. Adjustments to historical loss information are considered for differences in current loan-specific risk characteristics such as differences in underwriting standards, portfolio mix, delinquency levels, or term, as well as for changes in environmental conditions, such as unemployment rates, property values and changes in the competitive or regulatory environment.
14
We use an open pool loss rate methodology to model expected credit losses. To determine the loss rates using the open pool method, we start with our historical database of losses, segmenting the loans by loan purpose, product type and repayment period. A third-party model applying the open pool method is used to estimate an annual average loss rate by dividing the respective pool's quarterly historical losses by the pool's respective prior quarters’ ending unamortized loan cost balance and deriving an annual average loss rate from the historical quarterly loss rates. The model then adjusts the annual average loss rates based upon macroeconomic forecasts over a reasonable and supportable period, followed by a straight-line reversion to the historical loss rates. The adjusted annual average loss rates are applied to the forecasted pool balance within each segment. The forecasted balances in the loan pool segments are calculated based on a principal amortization using contractual maturity, factoring in further principal reductions from estimated prepayments. Estimated prepayments, or Constant Prepayment Rates ("CPRs") are developed from multiple loan characteristic considerations, such as property types, FICO scores, loan purpose, and prepayment penalty terms, which is the most significant driver of prepayment activity. The prepayment penalty terms differ between the short-term and long-term loans, and we have developed a CPR curve for our short-term loans (2-year or less) and one for our long-term loans (30-year). Data from 2012-2022 is used to develop prepayment rates for our long-term loans. Because of the prepayment penalty structure in our long-term loans, prepayments during the active penalty term are historically low and begin to ramp up after the prepayment penalty term. The active prepayment penalty term is considered for existing and new loans over the reasonable and supportable forecast period in determining estimated prepayments. We back-test the CPR curves on a quarterly basis and adjust the CPR curves as appropriate. The reasonable and supportable period is meant to represent the period in which we believe the forecasted macroeconomic variables can be reasonably estimated. Significant variables or assumptions incorporated in the macroeconomic forecasts include U.S. unemployment, treasury yields, U.S. real gross domestic product (GDP), and U.S. real estate housing prices. We consider multiple scenarios from different macroeconomic forecasts and use different forecast and revision periods for estimating lifetime expected credit losses.
We have determined that once a loan becomes nonperforming (90 or more days past due), it no longer shares the same risk characteristics of the other loans within its segment of homogeneous loans (pool). We pull these loans out of the segments and evaluate the loans individually using the practical expedient to determine the credit exposure. Nonperforming loans are considered collateral dependent. Using the practical expedient, the fair value of the underlying collateral, less estimated selling costs, is compared to the carrying value of the loan in the determination of a credit loss.
The allowance for loan losses is a valuation account that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on the loans. Loans are charged off against the allowance when we believe the uncollectibility of a loan balance is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off.
The allowance for loan losses is maintained at a level deemed adequate by management to provide for expected losses in the portfolio at the balance sheet date. While we use available information to estimate our required allowance for loan losses, future additions to the allowance for loan losses may be necessary based on changes in estimates resulting from economic and other conditions.
We made the accounting policy election not to measure an allowance for loan losses for accrued interest receivables. When a loan is placed on nonaccrual status, the accrued and unpaid interest is reversed as a reduction of interest income and accrued interest receivable. Accrued interest receivable is excluded from the amortized cost of loans and it is presented as accrued interest receivable in the Consolidated Balance Sheets.
We have made an election to apply the fair value option accounting to all our originated mortgage loans on a go-forward basis beginning October 1, 2022. We will consider applying FVO accounting to acquired loans on a case-by-case basis. The fair value option loans will be presented on a separate line item in the consolidated balance sheet. We will not record a CECL loan loss reserve on fair value option loans.
15
Deferred Tax Assets and Liabilities
Our deferred tax assets and liabilities arise from differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We determine whether a deferred tax asset is realizable based on facts and circumstances, including our current and projected future tax position, the historical level of our taxable income, and estimates of our future taxable income. In most cases, the realization of deferred tax assets is based on our future profitability. If we were to experience either reduced profitability or operating losses in a future period, the realization of our deferred tax assets may no longer be considered more likely than not and, accordingly, we could be required to record a valuation allowance on our deferred tax assets by charging earnings.
How We Assess Our Business Performance
Net income is the primary metric by which we assess our business performance. Accordingly, we closely monitor the primary drivers of net income which consist of the following:
Net Interest Income
Net interest income is the largest contributor to our net income and is monitored on both an absolute basis and relative to provisions for loan losses and operating expenses. We generate net interest income to the extent that the rate at which we lend in our portfolio exceeds the cost of financing our portfolio, which we primarily achieve through long-term securitizations. Accordingly, we closely monitor the financing markets and maintain consistent dialogue with investors and financial institutions as we evaluate our financing sources and cost of funds.
To evaluate net interest income, we measure and monitor: (1) the yields on our loans, (2) the costs of our funding sources, (3) our net interest spread and (4) our net interest margin. Net interest spread measures the difference between the rates earned on our loans and the rates paid on our funding sources. Net interest margin measures the difference between our annualized interest income and annualized interest expense, or net interest income, as a percentage of average loans outstanding over the specified time period.
Periodic changes in net interest income are primarily driven by: (1) origination volume and changes in average outstanding loan balances and (2) interest rates and changes in interest earned on our portfolio or paid on our debt. Historically, origination volume and portfolio size have been the largest contributors to the growth in our net interest income. We measure net interest income before and after interest expense related to our corporate debt and before and after our provisions for loan losses.
Credit Losses
We strive to minimize actual credit losses through our rigorous screening and underwriting process and life of loan portfolio management and special servicing practices. We closely monitor the credit performance of our loan portfolio, including delinquency rates and expected and actual credit losses, as a key factor in assessing our overall business performance.
Operating Expenses
We incur operating expenses from compensation and benefits related to our employee base, rent and other occupancy costs associated with our leased facilities, our third-party primary loan servicing vendors, professional fees to the extent we utilize third-party legal, consulting and advisory firms, and costs associated with the resolution and disposition of real estate owned, among other items. We monitor and strive to prudently manage operating expenses and to balance current period profitability with investment in the continued development of our platform. Because volume and portfolio size determine the magnitude of the impact of each of the above factors on our earnings, we also closely monitor origination volume along with all key terms of new loan originations, such as interest rates, loan-to-value ratios, estimated credit losses and expected duration.
Factors Affecting Our Results of Operations
We believe there are a number of factors that impact our business, including those discussed below and elsewhere in this Annual Report.
16
Our results of operations depend on, among other things, the level of our net interest income, the credit performance of our loan portfolio and the efficiency of our operating platform. These measures are affected by a number of factors, including the demand for investor real estate loans, the competitiveness of the market for originating or acquiring investor real estate loans, the cost of financing our portfolio, operating costs, the availability of funding sources and the underlying performance of the collateral supporting our loans. While we have been successful at managing these elements in the past, there are certain circumstances beyond our control, including any lingering impact of the COVID-19 pandemic, the Russia/Ukraine war, an expected recession, and macroeconomic conditions and market fundamentals, which can all affect each of these factors and potentially impact our business performance.
Origination Volume
Portfolio related net interest income is the largest contributor to our net income. We grew our portfolio related net interest income by $16.0 million or 16.7% from $96.6 million for the year ended December 31, 2021 to $112.6 million for the year ended December 31, 2022. The growth in net interest income is largely attributable to new loan originations which we have achieved by executing our principal strategies of expanding our broker network and further penetrating our network of existing brokers. We anticipate that our future performance will continue to depend on growing our origination/acquisition volume and believe that the large and highly fragmented nature of our core market provides meaningful opportunity to achieve this. We intend to grow our portfolio by continuing to serve and build loyalty within our existing network of brokers while expanding our network with new brokers through targeted marketing and improved brand awareness.
Our future performance could be impacted to the extent that our origination volumes decline as we rely on new loans to offset maturities and prepayments in our existing portfolio. To augment our core origination business, we continually assess opportunities to acquire portfolios of loans that meet our investment criteria. In our experience, portfolio acquisition opportunities have generally been more attractive and plentiful during market conditions when origination opportunities are less favorable. Accordingly, we believe our acquisition strategy not only expands our core business, but also provides a counter-cyclical benefit.
The investor real estate loan market is highly competitive which could affect our profitability and growth. We believe we compete favorably through diversified borrower access driven by our extensive network of mortgage brokers and by emphasizing a high level of real estate and financial expertise, customer service, and flexibility in structuring transactions, as well as by attracting and retaining experienced managerial and marketing personnel. However, some of our competitors may be better positioned to market their services and financing programs because of their ability to offer more favorable rates and terms and other services.
Availability and Cost of Funding
Our primary funding sources have historically included cash from operations, warehouse facilities, term securitizations, corporate debt and equity. We believe we have an established brand in the term securitization market and that this market will continue to support our portfolio growth with long-term financing. Changes in macroeconomic conditions can adversely impact our ability to issue securitizations and, thereby, limit our options for long-term financing. In consideration of this potential risk, we have entered into a credit facility for longer-term financing that will provide us with capital resources to fund loan growth in the event we are not able to issue securitizations.
17
Two of our seven warehouse repurchase and revolving loan facilities have interest payment obligations tied to the one-month USD London Interbank Offered Rate, or LIBOR. Five of our warehouse repurchase and revolving loan facilities have interest payment obligations tied to the Secured Overnight Offering Rate ("SOFR"). The authorized administrator of LIBOR confirmed during March 2021 that it intended to cease the publication or loss of representativeness of LIBOR. In particular, the last date of publication or representativeness of one-month USD LIBOR will be June 30, 2023. We expect that the index used in the calculation of the interest rate for our warehouse facilities and corporate debt will transition from LIBOR to a Secured Overnight Financing Rate (“SOFR”) or a suitable replacement index prior to June 30, 2023. As we renew our financing agreements with our warehouse facilities, we are working with our warehouse facilities to include language on the transition to SOFR. We do not expect the cessation of LIBOR nor the transition to a replacement index to have a material adverse effect on our cost of funding, results of operations or financial condition.
Loan Performance
We underwrite and structure our loans to minimize potential losses. We believe our fully amortizing loan structures and avoidance of large balloon payments, coupled with meaningful borrower equity in properties, limit the probability of losses and that our proven in-house asset management capability allows us to minimize potential losses in situations where there is insufficient equity in the property. Our income is highly dependent upon borrowers making their payments and resolving delinquent loans as favorably as possible. Macroeconomic conditions can, however, impact credit trends in our core market and have an adverse impact on financial results.
Macroeconomic Conditions
The investor real estate loan market may be impacted by a wide range of macroeconomic factors such as interest rates, residential and commercial real estate prices, home ownership and unemployment rates, and availability of credit, among others. We believe our prudent underwriting, conservative loan structures and interest rate protections, and proven in-house asset management capability leave us well positioned to manage changing macroeconomic conditions.
Operating Efficiency
We generate positive operating leverage to the extent that our revenue grows at a faster rate than our expenses. We believe our platform is highly scalable and that we can generate positive operating leverage in future periods, primarily due to the technology and other investments we have made in our platform to date and our focus on a scalable, cost-effective mortgage broker network to generate new loan originations.
Portfolio and Asset Quality
Key Portfolio Statistics
($ in thousands)
Total loans (UPB)
3,512,486
2,587,221
1,944,804
Loan count
8,893
6,964
5,878
Average loan balance
395
372
331
Weighted average loan-to-value
68.2
%
67.7
66.1
Weighted average coupon
7.95
7.76
8.51
Nonperforming loans (UPB) (A)
292,789
273,100
332,813
Nonperforming loans (% of total) (A)
8.34
10.56
17.11
(A) Reflects the UPB of loans 90 days or more past due or placed on nonaccrual status. Includes $39.6 million and $53.8 million of COVID-19 forbearance-granted loans 90 days or more past due as of December 31, 2022 and 2021, respectively.
Total Loans. Total loans reflects the aggregate UPB at the end of the period. It excludes deferred origination costs, acquisition discounts, fair value adjustments and allowance for loan losses.
Loan Count. Loan count reflects the number of loans at the end of the period. It includes all loans with an outstanding principal balance.
18
Average Loan Balance. Average loan balance reflects the average UPB at the end of the period (i.e., total loans divided by loan count).
Weighted Average Coupon. Weighted average coupon reflects the weighted average loan rate at the end of the period.
Weighted Average Loan-to-Value. Loan-to-value, or LTV, reflects the ratio of the original loan amount to the appraised value of the underlying property at the time of origination. In instances where the LTV at origination is not available for an acquired loan, the LTV reflects our best estimate of value at the time of acquisition. Weighted average LTV is calculated for the population of loans outstanding at the end of each specified period using the original loan amounts and appraised LTVs at the time of origination of each loan. LTV is a key statistic because requiring the borrower to invest more equity in the collateral minimizes our exposure for future credit losses.
Nonperforming Loans. Loans that are 90 or more days past due, except for certain loans in our COVID-19 forbearance program, in bankruptcy, in foreclosure, or not accruing interest are considered nonperforming loans. The dollar amount of nonperforming loans presented in the table above reflects the UPB of all loans that meet this definition.
Originations and Acquisitions
The following table presents new loan originations and acquisitions and includes average loan size, weighted average coupon and weighted average loan-to-value for the periods indicated:
Loan Count
Loan Balance
AverageLoan Size
WeightedAverageCoupon
WeightedAverageLTV
Year Ended December 31, 2022:
Loan originations — held for investment
4,133
1,730,526
419
7.9
69.2
Loan originations — held for sale
31,327
15,663
5.0
64.7
Total loan originations
4,135
1,761,853
426
68.0
Loan acquisitions — held for investment
14,455
1,032
8.8
62.0
Total loans originated and acquired
4,149
1,776,308
Year Ended December 31, 2021:
3,105
1,326,275
427
6.9
69.6
(—
)%
26
11,300
435
7.0
61.4
3,131
1,337,575
Year Ended December 31, 2020:
955
338,815
355
8.3
316
96,223
305
9.7
68.3
1,271
435,038
342
8.6
68.1
3,467
1,156
6.5
73.5
1,274
438,505
For the year ended December 31, 2022, we originated $1.8 billion of loans, which was an increase of $435.6 million, or 32.8% from $1.3 billion for the year ended December 31, 2021. The 2021 origination was increased by $891.2 million, or 204.9% from $435.0 million for the year ended December 31, 2020, due to the COVID-19 pandemic that adversely impacted our loan originations in 2020.
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Our total portfolio of loans held for investment consists of both loans held for investment carried at amortized cost, which are presented in the Consolidated Balance Sheets as loans held for investment, net, and loans held for investment at fair value, which are presented in the Consolidated Balance Sheets as loans held for investment, at fair value. The following tables show the various components of loans held for investment as of the dates indicated:
Unpaid principal balance
2,499,798
1,931,875
Valuation adjustments on FVO loans
7,463
27
(2
Deferred loan origination costs
33,429
33,360
23,600
Total loans held for investment, gross
3,553,378
2,533,185
1,955,473
Allowance for credit losses
(4,893
(4,262
(5,845
2,528,923
1,949,628
The following table illustrates the contractual maturities for our loans held for investment in aggregate UPB and as a percentage of our total held for investment loan portfolio as of December 31, 2022:
UPB
Loans due in less than one year
146,916
4.2
96,502
3.9
100,025
5.2
Loans due in one to five years
31,777
0.9
5,023
0.2
79,398
4.1
Loans due in more than five years
3,333,793
94.9
2,398,273
96.0
1,752,452
90.7
Total loans held for investment
100.0
Our allowance for loan losses increased to $4.9 million as of December 31, 2022, from $4.3 million as of December 31, 2021. The increase in allowance is primarily due to the increase in our loans held for investment carried at amortized cost from $2.5 billion as of December 31, 2021 to $3.3 billion as of December 31, 2022.
Our allowance decreased to $4.3 million as of December 31, 2021, from $5.8 million as of December 31, 2020. The decrease in allowance is primarily due to the broad improvement in the U.S economy in 2021 as the U.S. economy recovered from the adverse impacts caused by the COVID-19 pandemic.
Our allowance for loan losses is based on an analysis of historical loan loss data from January 1, 2015 through December 31, 2022, adjusted for macroeconomic forecasts. We strive to minimize actual credit losses through our rigorous screening and underwriting process, life of loan portfolio management and special servicing practices. Additionally, we believe borrower equity of 25% to 40% provides significant protection against credit losses should a loan become impaired. The various scenarios, the weighting of scenarios, as well as the forecast period and reversion to historical loss, is subject to change as conditions in the market change and the Company’s ability to forecast economic events evolves.
To estimate the allowance for loan losses in our non-FVO loans held for investment portfolio, we follow a detailed internal process, considering a number of different factors including, but not limited to, our ongoing analyses of loans, historical loss rates, relevant environmental factors, relevant market research, trends in delinquencies, effects and changes in credit concentrations, and ongoing evaluation of fair values.
20
The following table illustrates the activity in our allowance for loan losses over the periods indicated:
Allowance for credit losses:
Beginning balance
4,262
5,845
2,240
Impact of adopting ASC 326
137
Provision for loan losses
(1)
Charge-offs
(521
(1,291
(1,600
Ending balance
4,893
Total loans held for investment (UPB), excluding FVO (2)
3,243,854
2,498,466
1,930,334
Allowance for credit losses / loans held for investment, excluding FVO
0.15
0.17
0.30
Credit Quality – Total Portfolio of Loans Held for Investment
The following table provides delinquency information, by unpaid principal balance, on our held for investment loan portfolio as of the dates indicated:
December 31, 2022 (A)
COVID-19Forbearance
December 31, 2021 (A)
December 31, 2020 (A)
Performing/Accruing:
Current
2,969,989
84.6
120,884
2,068,023
82.7
188,466
1,445,131
74.9
259,147
30-59 days past due
186,051
5.3
33,668
127,046
5.1
36,579
89,284
4.6
32,115
60-89 days past due
63,657
1.8
6,902
31,629
1.3
8,262
62,694
3.2
34,493
90+ days past due
1,953
0.1
Total performing loans
3,219,697
91.7
161,454
2,226,698
89.1
233,307
1,599,062
82.8
327,708
Nonperforming/Nonaccrual:
<90 days past due
17,852
0.5
1,116
19,533
0.8
5,325
20,778
1.1
727
32,566
1,681
35,787
1.4
8,510
82,004
34,120
Bankruptcy
22,435
0.6
7,272
20,038
6,242
12,655
0.7
1,650
In foreclosure
219,936
6.3
29,482
197,742
39,045
217,376
11.2
27,868
Total nonperforming loans
39,551
10.9
59,122
17.2
64,365
201,005
292,429
392,073
Other than loans while they were in the COVID-19 forbearance program, loans that are 90+ days past due, in bankruptcy, in foreclosure, or not accruing interest are considered nonperforming loans. Nonperforming loans were $292.8 million, or 8.3% of our held for investment loan portfolio as of December 31, 2022, compared to $273.1 million, or 10.9% as of December 31, 2021, and $332.8 million, or 17.2% of the loan portfolio as of December 31, 2020. The decrease in total nonperforming loans as of December 31, 2022 compared to December 31, 2021 and 2020 was primarily attributable to loan resolutions by our Special Servicing department, along with improvement in the U.S. economy as the U.S economy recovers from the COVID-19 pandemic.
21
Resolutions of non-performing loans
Historically, most loans that become nonperforming resolve prior to converting to REO. This is due to low LTVs at origination and our active management of the portfolio. The following tables summarize the resolution activities of loans that were nonperforming or became nonperforming during the periods indicated. We resolved $142.2 million, $201.9 million, and $83.4 million of long-term and short-term nonperforming loans during the years ended December 31, 2022, 2021, and 2020, respectively. We also resolved $16.2 million, $10.7 million, and $4.4 million of nonperforming loans transferred to REO during the years ended December 31, 2022, 2021 and 2020, respectively. From these resolution activities, we realized net gains of $10.8 million, $7.5 million, and $2.7 million during the years ended December 31, 2022, 2021, and 2020, respectively. This is largely the result of collecting default interest and prepayment penalties in excess of the contractual interest due and collected.
The table below includes nonperforming loan resolutions for our long-term loans and REO's.
Long-Term Loans
December 31, 2022
December 31, 2021
December 31, 2020
Gain /(Loss)
Resolved — paid in full
50,441
5,073
62,703
4,106
45,662
2,029
Resolved — paid current
46,062
449
45,654
650
37,705
1,213
Resolved — REO sold
10,204
1,602
10,151
226
4,362
(498
Total resolutions
106,707
7,124
118,508
4,982
87,729
2,744
Recovery rate on resolved nonperforming UPB
106.7
104.2
103.1
The table below includes resolutions for our short-term nonperforming loans and REO's, now being held for investment, and also includes loans that were granted a COVID-19 forbearance in 2020. Prior to January 1, 2020, nonperforming loan resolutions presented only consisted of long-term nonperforming loans held for investment since the short-term loans, or loans with a maturity of two-year or less, were being held for sale until later in 2020. The short-term loans do not require prepayment fees and usually result in a lower gain when paid in full, as compared to long term loans.
Short-Term Loans
36,516
2,100
43,613
2,312
9,192
61
49,942
195
5,966
1,474
534
22
51,674
3,635
94,089
2,529
107.0
102.7
N/A
Our actual losses incurred have been small as a percentage of nonperforming loans held for investment. The table below shows our actual loan losses for the periods indicated.
Average nonperforming loans for the period (1)
266,129
307,562
246,972
521
1,291
1,600
Charge-offs / Average nonperforming loans for the period (1)
0.20
0.42
0.65
Concentrations – Loans Held for Investment
As of December 31, 2022, our held for investment loan portfolio was concentrated in investor 1-4 loans, representing 52.7% of the UPB and mixed use properties represented 12.6% of the UPB. No other property type represented more than 10.0% of our held for investment loan portfolio. By geography, the principal balance of our loans held for investment were concentrated 22.8% in California, 19.9% in New York, 13.3% in Florida, and 7.5% in New Jersey.
Property Type
% of Total UPB
Investor 1-4
5,317
1,851,538
52.7
Mixed use
1,056
443,330
12.6
Retail
637
305,361
8.7
Multifamily
546
301,342
Warehouse
344
223,271
6.4
Office
453
199,034
5.7
Other (1)
540
188,610
Geography (State)
California
1,251
802,005
22.8
New York
1,259
698,945
19.9
Florida
1,218
466,690
13.3
New Jersey
835
261,656
7.5
4,330
1,283,190
36.5
Real Estate Owned (REO)
REO includes real estate we acquire through foreclosure or by deed-in-lieu of foreclosure. REO assets are initially recorded at fair value, less estimated costs to sell, on the date of foreclosure. Adjustments that reduce the carrying value of the loan to the fair value of the real estate at the time of foreclosure are recognized as charge-offs in the allowance for loan losses. Positive adjustments at the time of foreclosure are recognized in other operating income. After foreclosure, we periodically obtain new valuations and any subsequent changes to fair value, less estimated costs to sell, are reflected as valuation adjustments.
As of December 31, 2022, our REO included 27 properties with a carrying value of $13.3 million compared to 34 properties with a carrying value of $17.6 million as of December 31, 2021.
Key Performance Metrics
Average loans
3,092,198
2,125,847
2,043,665
Portfolio yield
7.77
8.56
8.19
Average debt — portfolio related
2,750,822
1,814,048
1,803,188
Average debt — total company
2,956,801
1,968,938
1,885,306
Cost of funds — portfolio related
4.64
4.71
4.87
Cost of funds — total company
5.32
5.38
5.30
Net interest margin — portfolio related
3.64
4.54
3.89
Net interest margin — total company
2.69
3.57
3.30
0.02
0.06
0.08
Pre-tax return on equity
12.23
15.58
10.69
Return on equity
8.93
11.45
8.22
23
Average Loans
Average loans reflects the daily average of total outstanding loans, including both loans held for investment and loans held for sale, as measured by UPB, over the specified time period.
Portfolio Yield
Portfolio yield is an annualized measure of the total interest income earned on our loan portfolio as a percentage of average loans over the given period. Interest income includes interest earned on performing loans, cash interest received on nonperforming loans, default interest and prepayment fees. Portfolio yield is lower in 2022 primarily from a delay in the recovery of delinquent interest as compared to 2021.
Average Debt — Portfolio Related and Total Company
Portfolio-related debt consists of borrowings related directly to financing our loan portfolio, which includes our warehouse repurchase facilities and securitizations. Total company debt consists of portfolio- related debt and corporate debt. The measures presented here reflects the monthly average of all portfolio- related and total company debt, as measured by outstanding principal balance, over the specified time period.
Cost of Funds — Portfolio Related and Total Company
Portfolio related cost of funds is an annualized measure of the interest expense incurred on our portfolio-related debt as a percentage of average portfolio-related debt outstanding over the given period. Total company cost of funds is an annualized measure of the interest expense incurred on our portfolio-related debt and corporate debt outstanding over the given period. Interest expense includes the amortization of expenses incurred in connection with our portfolio related financing activities and corporate debt. Through the issuance of long-term securitizations, we have been able to fix a significant portion of our borrowing costs over time. The strong credit performance on our securitizations has allowed us to issue debt at attractive rates. Our portfolio related cost of funds decreased to 4.64% for the year ended December 31, 2022 from 4.71% and 4.87% for the years ended December 31, 2021 and 2020, respectively.
Net Interest Margin — Portfolio Related and Total Company
Portfolio related net interest margin measures the difference between the interest income earned on our loan portfolio and the interest expense paid on our portfolio-related debt as a percentage of average loans over the specified time period. Total company net interest margin measures the difference between the interest income earned on our loan portfolio and the interest expense paid on our portfolio-related debt and corporate debt as a percentage of average loans over the specified time period.
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The following tables show the average outstanding balance of our loan portfolio and portfolio-related debt, together with interest income and the corresponding yield earned on our portfolio, and interest expense and the corresponding rate paid on our portfolio-related debt for the periods indicated:
Interest
Average
Income /
Yield /
Balance
Expense
Rate
Loan portfolio:
Loans held for sale
49,194
15,794
110,810
Loans held for investment
3,043,003
2,110,053
1,932,855
Total loans
Debt:
Warehouse and repurchase facilities
292,490
17,454
5.97
183,663
9,706
5.28
168,099
8,352
4.97
2,458,332
110,269
4.49
1,630,385
75,680
1,635,089
79,474
4.86
Total debt - portfolio related
Corporate debt
205,979
14.31
(5)
154,890
13.31
(4)
82,117
14.67
(3)
Total debt
157,195
105,995
1,885,305
99,875
Net interest spread - portfolio related (1)
3.13
3.85
3.32
Net interest margin - portfolio related
Net interest spread - total company (2)
2.46
3.18
2.89
Net interest margin - total company
Charge-Offs
The charge-offs ratio reflects charge-offs as a percentage of average loans held for investment carried at amortized cost over the specific time period. We do not record charge-offs on FVO loans which are carried at estimated fair value. We also do not record charge-offs on our loans held for sale which are carried either at fair value, or carried at the lower of cost or estimated fair value.
25
Pre-Tax Return on Equity and Return on Equity
Pre-tax return on equity and return on equity reflect income before income taxes, and net income including net income attributable to noncontrolling interest, respectively, as a percentage of the monthly average total stockholders’ equity including noncontrolling interest over the specified period.
Income before income taxes (A)
Net income (B)
Monthly average balance:
Stockholders' / Members' equity (C)
364,282
255,331
216,289
Pre-tax return on equity (A)/(C)
12.2
15.6
10.7
Return on equity (B)/(C)
8.9
11.4
8.2
Components of Results of Operations
Interest Income
We accrue interest on the UPB of our loans in accordance with the individual terms and conditions of each loan, discontinuing interest and reversing previously accrued interest once a loan becomes 90 days or more past due (nonaccrual status). When a loan is placed on nonaccrual status, the accrued and unpaid interest is reversed as a reduction to interest income and accrued interest receivable. Interest income is subsequently recognized only to the extent that cash payments are received or when the loan has returned to accrual status. Payments received on nonaccrual loans are first applied to interest due, then principal. Interest accrual resumes once a borrower has made all principal and interest payments due, bringing the loan back to current status.
Interest income on loans held for investment is comprised of interest income on loans and prepayment fees less the amortization of deferred net costs related to the origination of loans. Interest income on loans held for sale is comprised of interest income earned on loans prior to their sale. The net fees and costs associated with loans held for sale are deferred as part of the carrying value of the loan and recognized as a gain or loss on the sale of the loan.
Interest Expense — Portfolio Related
Portfolio related interest expense is incurred on the debt we incur to fund our loan origination and portfolio activities and consists of our warehouse repurchase facilities and securitizations. Portfolio related interest expense also includes the amortization of expenses incurred as a result of issuing the debt, which are amortized using the level yield method. Key drivers of interest expense include the debt amounts outstanding, interest rates, and the mix of our securitizations and warehouse liabilities.
Net Interest Income — Portfolio Related
Portfolio related net interest income represents the difference between interest income and portfolio related interest expense.
Interest Expense — Corporate Debt
Interest expense on corporate debt primarily consists of interest expense paid with respect to the 2021 Term Loan and the 2022 Term Loan, as reflected on our consolidated balance sheets, and the related amortization of deferred debt issuance costs.
Net interest income represents the difference between portfolio related net interest income and interest expense on corporate debt.
Provision for Loan Losses
Effective January 1, 2020, we adopted ASU 2016-13 Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments replacing the incurred loss accounting approach with the current expected credit loss (CECL) approach. Under the CECL methodology, the allowance for credit losses is calculated using a third-party model with our historical loss rates by segment, loans position as of the balance sheet date, and assumptions from us.
Other Operating Income
Gain on Disposition of Loans. When we sell a loan held for sale, we record a gain or loss that reflects the difference between the proceeds received for the sale of the loans and their respective carrying values. The gain or loss that we ultimately realize on the sale of our loans held for sale is primarily determined by the terms of the originated loans, current market interest rates and the sales price of the loans. In addition, when we transfer a loan to REO, we record the REO at its fair value at the time of the transfer. The difference between the fair value of the real estate and the carrying value of the loan is recorded as a gain or loss. Lastly, when our acquired loans, which were purchased at a discount, pay off, we record a gain related to the recognition of the remaining purchase discount.
Unrealized Gain/(Loss) on Fair Value Loans. We have elected to apply the fair value option accounting to all of our originated mortgage loans on a go-forward basis beginning October 1, 2022. We also elected to account for certain purchased distressed loans at fair value using FASB ASC Topic 825, Financial Instruments (ASC 825). We regularly estimate the fair value of these loans as discussed more fully in the notes to our consolidated financial statements included elsewhere in this Annual Report. Changes in fair value are reported as a component of other operating income within our consolidated statements of income.
Other Income. Other income includes the following:
Unrealized Gains/(Losses) on Retained Interest Only Securities. As part of the proceeds received for the sale of our held for sale loans, we may receive an interest only security that we mark to fair value at the end of each period.
Fee Income. In certain situations, we collect fee income by originating loans and realizing miscellaneous fees such as late fees.
Compensation and Employee Benefits. Costs related to employee compensation, commissions and related employee benefits, such as health, retirement, and payroll taxes.
Rent and Occupancy. Costs related to occupying our locations, including rent, maintenance and property taxes.
Loan Servicing. Costs related to our third-party servicers.
Professional Fees. Costs related to professional services, such as external audits, legal fees, tax, compliance and outside consultants.
Real Estate Owned, Net. Costs related to our real estate owned, net, including gains/(losses) on disposition of REO, maintenance of REO properties, and taxes and insurance.
Other Operating Expenses. Other operating expenses consist of general and administrative costs such as, travel and entertainment, marketing, data processing, insurance and office equipment.
Provision for Income Taxes
The provision for income taxes consists of the current and deferred U.S. federal and state income taxes we expect to pay, currently and in future years, with respect to the net income for the year. The amount of the provision is derived by adjusting our reported pretax income with various permanent differences. The tax-adjusted income amount is then multiplied by the applicable federal and state income tax rates to arrive at the provision for income taxes.
Consolidated Results of Operations
The following table summarizes our consolidated results of operations for the periods indicated:
Interest expense - portfolio related
Net interest income - portfolio related
Interest expense - corporate debt
Year Ended December 31, 2022 Compared to Year Ended December 31, 2021
$ Change
% Change
58,375
32.1
42,337
49.6
16,038
16.6
Interest Income. Interest income increased by $58.4 million, or 32.1%, to $240.3 million during the year ended December 31, 2022, compared to $182.0 million during the year ended December 31, 2021. The increase was primarily attributable to higher portfolio balances offset by a decrease in the average yield. The average yield decreased to 7.77% from 8.56%. Average loans increased $966.4 million, or 45.4%, from $2.1 billion for the year ended December 31, 2021 to $3.1 billion for the year ended December 31, 2022. The decrease in average yield is attributable to higher collection of delinquent and default interest in 2021.
The following table distinguishes between the change in interest income attributable to change in volume and the change in interest income attributable to change in rate. The effect of changes in volume is determined by
28
multiplying the change in average loan balance ($966.4 million) by the previous period’s average yield (8.56%). Similarly, the effect of rate changes is calculated by multiplying the change in average yield (0.79%) by the current period’s average loan balance ($3.1 billion).
Year Ended December 31, 2022 and 2021
AverageLoans
InterestIncome
AverageYield
Year Ended December 31, 2022
Year Ended December 31, 2021
Volume variance
966,351
82,718
Rate variance
(24,343
(0.79
Total interest income variance
Interest Expense — Portfolio Related. Portfolio related interest expense consists of interest incurred on our warehouse facilities and securitizations, which increased by $42.3 million, or 49.4%, to $127.7 million for the year ended December 31, 2022, from $85.4 million for the year ended December 31, 2021. The increase in portfolio related interest expense in 2022 was primarily attributable to an increase in loan portfolio.
The following table presents information regarding the increase in portfolio related interest expense and distinguishes between the dollar amount of change in interest expense attributable to changes in the average outstanding debt balance (volume) versus changes in cost of funds (rate) for the years ended December 31, 2022 and 2021.
AverageDebt (1)
InterestExpense
Cost ofFunds
936,774
44,093
(1,756
(0.06
Total interest expense variance
Net Interest Income After Provision for Loan Losses
Net interest income after provision for loan losses increased 7.5% over the prior year driven by higher net interest income.
8,863
43.0
7,175
9.4
1,444
(494.5
5,731
Interest Expense — Corporate Debt. Corporate debt interest expense increased by $8.9 million from $20.6 million for the year ended December 31, 2021 to $29.5 million for the year ended December 31, 2022 primarily due to the fees associated with paying off our 2021 term loan early. The corporate debt balance was $215.0 million as of December 31, 2022 compared to $170.8 million as of December 31, 2021, as a result of the 2022 Term Loan agreement we entered into in March 2022.
Provision for (reversal of) Loan Losses. Our provision for loan losses increased by approximately $1.4 million from the reversal of $0.3 million for the year ended December 31, 2021 to a provision of $1.2 million for the year ended December 31, 2022. The increase in provision for loan losses is primarily attributable to an increase in general reserve resulting from the increased non-FVO loan portfolio.
The table below presents the various components of other operating income for the year ended December 31, 2022 compared to the year ended December 31, 2021. The $14.0 million net increase is primarily due to the unrealized gains related to loans originated after September 30, 2022 and the 2022 election of fair value option for our Century mortgage servicing rights.
(785
(9.9
%)
Unrealized gain on fair value loans
8,236
28400.0
Other income
6,586
2466.7
14,037
171.4
Total operating expenses increased by 33.6%, or $15.0 million to $59.7 million during the year ended December 31, 2022 from $44.7 million during the year ended December 31, 2021. The increase was driven by higher origination activity as well as the fair value election for loans originated in the fourth quarter.
11,268
58.7
(21
(1.2
4,016
48.5
398
10.5
(3,220
(102.2
2,568
30.3
15,009
33.6
Compensation and Employee Benefits. Compensation and employee benefits increased from $19.2 million during the year ended December 31, 2021 to $30.5 million during year ended December 31, 2022. The increase was attributable to higher commission expense driven by the increase in loan originations and not deferring compensations costs attributable to loan origination activities on FVO loans starting on October 1, 2022.
Rent and Occupancy. Rent and occupancy expenses remained relatively consistent between $1.7 million to $1.8 million during the years ended December 31, 2022 and 2021.
Loan Servicing. Loan servicing expenses increased from $8.3 million during the year ended December 31, 2021 to $12.3 million during the year ended December 31, 2022. The $4.0 million increase during the year ended December 31, 2022 is mainly due to the increase in our loan portfolio.
Professional Fees. Professional fees remained relatively consistent from $3.8 million for the year ended December 31, 2021 to $4.2 million for the year ended December 31, 2022.
Net Expenses of Real Estate Owned. Net expenses of real estate owned decreased from $3.2 million during the year ended December 31, 2021 to income of $70 thousand during the year ended December 31, 2022. The $3.2 million decrease is mainly due to a higher gain on sale of REOs resolved by our special servicing team.
30
Other Operating Expenses. Other operating expenses increased from $8.5 million for the year ended December 31, 2021 to $11.1 million for the year ended December 31, 2022, mainly due to an increase in appraisal costs on higher origination volume and resumed marketing activity via trade shows after a pandemic-impacted 2021.
Income Tax Expense. Income tax expense was $12.0 million for the year ended December 31, 2022, compared to $10.6 million for the year ended December 31, 2021. Our consolidated effective tax rate as a percentage of pre-tax income for 2022 was 27.2%, compared to 26.6% for 2021. The 2021 effective tax rate differed from the federal statutory rate of 21% principally because of state taxes.
Year Ended December 31, 2021 Compared to Year Ended December 31, 2020
14,646
(2,440
(2.8
17,086
21.5
Interest Income. Interest income increased by $14.6 million, or 8.8%, to $182.0 million during the year ended December 31, 2021, compared to $167.3 million during the year ended December 31, 2020. The increase is primarily attributable to the increase in average yield and an increase in average loans (volume). The average yield increased to 8.56% from 8.19%. Average loans increased $82.2 million, or 4.0%, from $2.0 billion for the year ended December 31, 2020 to $2.1 billion for the year ended December 31, 2021. The increase in average yield is primarily attributable to the recognition of default interest and prepayment fees for resolutions of nonperforming loans.
The following table distinguishes between the change in interest income attributable to change in volume and the change in interest income attributable to change in rate. The effect of changes in volume is determined by multiplying the change in average loan balance (i.e., $82.2 million) by the previous period’s average yield (i.e., 8.19%). Similarly, the effect of rate changes is calculated by multiplying the change in average yield (i.e., 0.37%) by the current period’s average loan balance (i.e., $2.1 billion).
Year Ended December 31, 2021 and 2020
Year Ended December 31, 2020
82,182
6,729
7,917
0.37
Interest Expense — Portfolio Related. Portfolio related interest expense consists of interest incurred on our warehouse facilities and securitizations, which decreased by $2.4 million, or 2.8%, to $85.4 million for the year ended December 31, 2021, from $87.8 million for the year ended December 31, 2020. The decrease in portfolio related interest expense in 2021 was primarily attributable to the lower cost of funds, which decreased to 4.71% for the year ended December 31, 2021 from 4.87% for the year ended December 31, 2020. The decrease in cost of funds was partially offset by the increase in average debt balance. The lower cost of funds was mainly attributable to improved securitization spreads.
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The following table presents information regarding the increase in portfolio related interest expense and distinguishes between the dollar amount of change in interest expense attributable to changes in the average outstanding debt balance (volume) versus changes in cost of funds (rate) for the years ended December 31, 2021 and 2020.
10,860
529
(2,969
(0.16
8,560
71.0
8,526
(5,360
(105.8
13,886
22.3
Interest Expense — Corporate Debt. Corporate debt interest expense increased by $8.6 million from $12.0 million for the year ended December 31, 2020 to $20.6 million for the year ended December 31, 2021 primarily due to the increase in corporate debt balance. The corporate debt balance was $170.8 million as of December 31, 2021 compared to $78.0 million as of December 31, 2020, as a result of 2021 Term Loan agreement we entered into in February 2021.
Provision for Loan Losses. Our provision for loan losses decreased by approximately $5.4 million from the provision of $5.1 million for the year ended December 31, 2020 to a reversal of $0.3 million for the year ended December 31, 2021. The decrease in provision for loan losses is primarily attributable to the improvement in the U.S economy as the U.S economy continues to recover from the negative impacts caused by the COVID-19 pandemic in 2020.
The table below presents the various components of other operating income for the year ended December 31, 2021 compared to the year ended December 31, 2020. The $1.9 million net increase is primarily due to the unrealized loss in 2020 related to interest-only securities that matured in 2020. The unrealized loss on interest-only securities is included in other income (expense).
(413
(93.4
1,965
(115.7
1,868
29.6
32
Total operating expenses decreased by 2.0%, or $0.9 million to $44.7 million during the year ended December 31, 2021 from $45.6 million during the year ended December 31, 2020. This decrease is primarily attributable to a higher percentage of direct loan origination costs included in the compensation and employee benefits and other operating expenses in 2020 due to the suspension of loan production from mid-March through August.
(1,541
-7.4
1.5
480
6.2
(457
(10.8
494
18.6
88
1.0
(910
-2.0
Compensation and Employee Benefits. Compensation and employee benefits decreased from $20.7 million during the year ended December 31, 2020 to $19.2 million during the year ended December 31, 2021. During April through August of 2020, when loan originations were suspended and staff was working on offering existing borrowers the COVID-19 forbearance program, compensation costs for the employees were expensed when, under normal operating conditions, the same compensation costs would be deferred over new loan production.
Rent and Occupancy. Rent and occupancy expenses remained relatively consistent at approximately $1.8 million during the years ended December 31, 2020 and 2021 due to no change in office space.
Loan Servicing. Loan servicing expenses increased from $7.8 million during the year ended December 31, 2020 to $8.3 million during the year ended December 31, 2021. The $0.5 million increase during the year ended 2021 is mainly due to the increase in our loan portfolio.
Professional Fees. Professional fees decreased from $4.2 million for the year ended December 31, 2020 to $3.8 million for the year ended December 31, 2021 mainly due to the decrease in legal fees related to the IPO class action lawsuit which was dismissed in January 2021.
Net Expenses of Real Estate Owned. Net expenses of real estate owned increased from $2.7 million during the year ended December 31, 2020 to $3.2 million during the year ended December 31, 2021. The $0.5 million increase is mainly due to a smaller gain on disposition and the increase in taxes and insurance for the properties.
Other Operating Expenses. Other operating expenses slightly increased from $8.4 million for the year ended December 31, 2020 to $8.5 million for the year ended December 31, 2021 mainly due to the increase in appraisal fee expenses.
Income Tax Expense. Income tax expense was $10.6 million for the year ended December 31, 2021, compared to $5.4 million for the year ended December 31, 2020. Our consolidated effective tax rate as a percentage of pre-tax income for 2021 was 26.6%, compared to 23.1% for 2020. The 2021 effective tax rate differed from the federal statutory rate of 21% principally because of state taxes.
33
Quarterly Results of Operations
The following table sets forth certain financial information for each completed fiscal quarter since the quarter ended March 31, 2021. The quarterly information has been prepared on the same basis as the consolidated financial statements and includes all adjustments (consisting of normal recurring adjustments) that, in the opinion of management, are necessary for a fair presentation of the information presented. This information should be read in conjunction with the consolidated financial statements and related notes thereto included elsewhere in this Annual Report. Operating results for interim periods are not necessarily indicative of the results that may be expected for a full fiscal year.
The following tables set for our unaudited quarterly results for the periods indicated:
Three Months Ended
December 31,2022
September 30,2022
June 30,2022
March 31,2022
December 31,2021
September 30,2021
June 30,2021
March 31,2021
(unaudited)
65,632
63,419
59,243
52,049
49,360
46,923
44,978
40,707
40,854
34,561
28,752
23,556
23,666
20,321
20,566
20,832
24,778
28,858
30,491
28,493
25,694
26,602
24,412
19,875
2.84
3.59
4.10
4.25
4.27
4.83
4,139
4,011
4,182
17,140
4,462
4,488
4,309
7,350
20,639
24,847
26,309
11,353
21,232
22,114
20,103
12,525
2.36
3.09
3.54
1.69
3.53
4.13
3.98
2.59
(437
580
279
730
377
228
(1,000
105
21,076
24,267
26,030
10,623
20,855
21,886
21,103
12,420
Other operating income (expense)
11,029
2,509
3,039
5,648
2,617
339
2,432
2,801
20,413
12,727
14,279
12,250
12,095
11,298
10,650
10,617
11,692
14,049
14,790
4,021
11,377
10,927
12,885
4,604
Less income (loss) attributable to noncontrolling interest
(235
307
126
110
3,465
3,759
4,019
790
3,024
2,905
3,432
1,208
8,462
9,983
10,645
3,121
8,353
8,022
9,453
3,396
Liquidity and Capital Resources
Sources and Uses of Liquidity
We fund our lending activities primarily through borrowings under our warehouse repurchase facilities, securitizations, other corporate-level debt, equity and debt securities, and net cash provided by operating activities to manage our business. We use cash to originate and acquire investor real estate loans, repay principal and interest on our borrowings, fund our operations and meet other general business needs.
Cash and Cash Equivalents
Our total liquidity plus available warehouse capacity was $559.3 million as of December 31, 2022 comprised of $45.2 million in cash, $14.0 million of available borrowings for unencumbered loans and $500.1 million of available warehouse capacity.
As of December 31, 2021, we had liquidity of approximately $47.0 million in cash and cash equivalents comprised of approximately $36.0 million of unrestricted cash and $11.0 million of available liquidity on unfinanced loans. As of December 31, 2021, we had $349.9 million of available capacity under our warehouse and repurchase facilities.
During the year ended December 31, 2022, we generated approximately $14.5 million of net cash and cash equivalents from operations, investing and financing activities. During the year ended December 31, 2021, we used approximately $27.3 million of net cash and cash equivalents from operations, investing and financing activities.
34
Warehouse Facilities
As of December 31, 2022, we had five non-mark-to-market warehouse facilities and one modified mark-to-market warehouse facility to support our loan origination and acquisition facilities. One agreement is a two-year warehouse repurchase facility, three agreements are one-year warehouse repurchase facilities and two agreements are three-year warehouse facilities. The borrowings are collateralized by primarily performing loans, two of the warehouse facilities bear interest at one-month LIBOR and four warehouse facility at SOFR, all at margins that range from 2.75% to 4.50%. We also had a short term repurchase agreement with a maximum borrowing capacity of $18.8 million. Borrowing under these facilities was $331.7 million with $500.1 million of available capacity under our warehouse and repurchase facilities as of December 31, 2022.
As of December 31, 2021, we had four non-mark-to-market warehouse facilities and one modified mark-to-market warehouse facility to support our loan origination and acquisition facilities. One agreement is a two-year warehouse repurchase facility, two agreements are one-year warehouse repurchase facilities and two agreements are three-year warehouse facilities. The borrowings are collateralized by primarily performing loans, bearing interest at one-month LIBOR with a 0.75% floor plus a margin that ranges from 2.75% to 4.50%. Borrowing under these facilities was $300.1 million with $349.9 million of available capacity under our warehouse and repurchase facilities as of December 31, 2021.
All warehouse facilities fund less than 100% of the principal balance of the mortgage loans we own requiring us to use working capital to fund the remaining portion. We may need to use additional working capital if loans become delinquent, because the amount permitted to be financed by the facilities may change based on the delinquency performance of the pledged collateral.
All borrower payments on loans financed under the warehouse facilities are segregated into pledged accounts with the loan servicer. All principal amounts in excess of the interest due are applied to reduce the outstanding borrowings under the warehouse facilities, which then allows us to draw additional funds on a revolving basis under the facilities. The revolving warehouse facilities also contain customary covenants, including but not limited to financial covenants that require us to maintain a minimum net worth, a maximum debt-to-net worth ratio and a ratio of a minimum earnings before interest, taxes, depreciation and amortization to interest expense. If we fail to meet any of the covenants or otherwise default under the facilities, the lenders have the right to terminate their facility and require immediate repayment, which may require us to sell our loans at less than optimal terms. As of December 31, 2022, we were in compliance with these covenants.
From May 2011 through December 2022, we have completed 25 securitizations, issuing $5.4 billion in principal amount of securities to third parties. All borrower payments are segregated into remittance accounts at the primary servicer and remitted to the trustee of each trust monthly. We are the sole beneficial interest holder of the applicable trusts, which are variable interest entities included in our consolidated financial statements. The transactions are accounted for as a secured borrowings under U.S. GAAP. Tables summarizing the investor real estate loans securitized, securities issued, securities retained by the Company at the time of the securitization, and as of December 31, 2022 and 2021, the stated maturity for each securitization, the outstanding bond balances, and the weighted average rate on the securities for the Trusts as of December 31, 2022 and 2021, are included in Item 15. Exhibits, Financial Statement Schedules. The securities are callable by us when the stated principal balance is less than a certain percentage, ranging from 10%—30%, of the original stated principal balance of loans at issuance. As a result, the actual maturity date of the securities issued will likely be earlier than their respective stated maturity date.
Our intent is to use the proceeds from the issuance of new securities primarily to repay our warehouse borrowings and originate new investor real estate loans in accordance with our underwriting guidelines, as well as for general corporate purposes. Our financing sources may include borrowings in the form of additional bank credit facilities (including term loans and revolving credit facilities), repurchase agreements, warehouse repurchase facilities and other sources of private financing. We also plan to continue using securitization as long-term financing for our portfolio, and we do not plan to structure any securitizations as sales or utilize off-balance-sheet vehicles. We believe any financing of assets and/or securitizations we may undertake will be sufficient to fund our working capital requirements.
35
Cash Flows
The following table summarizes the net cash provided by (used in) operating activities, investing activities and financing activities as of the periods indicated:
Cash provided by (used in):
Operating activities
48,674
57,622
54,892
Investing activities
(908,238
(656,483
87,739
Financing activities
874,016
626,172
(149,890
Net change in cash, cash equivalents, and restricted cash
14,452
27,311
(7,259
Operating Activities
Cash flows from operating activities primarily includes net income adjusted for (1) non-cash items including depreciation, provision for loan loss, discount accretion, and valuation changes, (2) changes in the balances of operating assets and liabilities, (3) gain on disposition of loans.
For the year ended December 31, 2022, our net cash provided by operating activities of $48.7 million consisted mainly of $32.5 million in net income, and $32.2 million proceeds from sales of loans held for sale.
For the year ended December 31, 2021, our net cash provided by operating activities of $57.6 million consisted mainly of $29.2 million in net income, and $20.2 million add-back of noncash debt issuance discounts and costs amortization.
For the year ended December 31, 2020, our net cash provided by operating activities of $54.9 million consisted mainly of $96.1 million cash used to originate held for sale loans, offset by $79.6 million proceeds, net of repurchases, from sale of loans held for sale, $19.4 million in repayments on loans held for sale, and net income of $17.8 million.
Investing Activities
For the year ended December 31, 2022, our net cash used in investing activities of $908.2 million consisted mainly of $1.7 billion in cash used to originate held for investment loans, offset by $541.7 million in cash received in payments on held for investment loans and loans at fair value and by $292.5 million of proceeds from sales of loans originally classified as held for investment.
For the year ended December 31, 2021, our net cash used in investing activities of $656.5 million consisted mainly of $1.3 billion in cash used to originate held for investment loans, offset by $568.8 million in cash received in payments on held for investment loans and by $135.8 million of proceeds from sales of loans originally classified as held for investment.
For the year ended December 31, 2020, our net cash provided by investing activities of $87.7 million consisted mainly of $343.6 million in cash used to originate held for investment loans, offset by $342.0 million in cash received in payments on held for investment loans and by $99.6 million of proceeds from sales of loans originally classified as held for investment. We used $8.7 million in cash for escrow and corporate advances on loans held in the portfolio. We also received cash of $7.5 million from the sale of REO.
Financing Activities
For the year ended December 31, 2022, our net cash provided by financing activities of $874.0 million consisted mainly of $1.7 billion in borrowings from our warehouse and repurchase facilities and $1.4 billion in securitizations issued, respectively. The cash generated was offset by payments we made of $1.7 billion and $543.6 million on our warehouse and repurchase facilities and securitizations issued, respectively.
36
For the year ended December 31, 2021, our net cash provided by financing activities of $626.2 million consisted mainly of $1.2 billion in borrowings from our warehouse and repurchase facilities and $977.7 million in securitizations issued, respectively. The cash generated was offset by payments we made of $989.4 million and $643.5 million on our warehouse and repurchase facilities and securitizations issued, respectively.
For the year ended December 31, 2020, our net cash used in financing activities of $149.9 million consisted mainly of $420.2 million and $536.7 million in cash from borrowings from our warehouse repurchase facilities and securitizations issued, respectively. This cash generated was offset by payments we made of $766.7 million and $398.3 million on our warehouse and repurchase facilities and securitizations issued, respectively. We received cash proceeds from the sale of our common stock in the IPO of $100.8 million, a portion of which we used to repay $75.0 million of principal on our corporate debt. We also received cash of $41.0 million in net proceeds from the issuance of preferred stock. We used cash of $8.9 million for debt issuance costs.
April 2020 Preferred Stocks and Warrants
On April 5, 2020, we sold 45,000 shares of Series A Convertible Preferred Stock and Warrants to purchase 3,013,125 shares of our common stock in a private placement to two of our largest stockholders. On October 8, 2021, we exercised our option to convert all of the 45,000 outstanding shares of Series A Convertible Preferred Stock into 11,688,310 shares of our common stock.
The Warrants are exercisable at any time and from time to time, in whole or in part, by the holders until April 5, 2025 at an exercise price of $2.96 per share of common stock with respect to 2,008,750 of the Warrants, and at an exercise price of $4.94 per share of common stock with respect to 1,004,374 of the Warrants.
Contractual Obligations and Commitments
On February 5, 2021, we entered into a five-year $175.0 million syndicated corporate debt agreement (“2021 Term Loan”). The 2021 Term Loan had an interest rate equal to one-month LIBOR plus 8.00% with a 1.00% LIBOR floor and was paid off in March 2022. As of December 31, 2021, the balance of the 2021 Term Loan was $170.8 million.
On March 15, 2022, we entered into a five-year $215.0 million syndicated corporate debt agreement ("the 2022 Term Loan"). The 2022 Term Loan bears interest at a fixed rate of 7.125% and matures on March 15, 2027. Interest on the 2022 Term Loan is paid every six months. A portion of the net proceeds from the 2022 Term Loan was used to redeem all the amounts owed pursuant to the 2021 Term Loan. The remaining portion of the net proceeds from the 2022 Term Loan is used for loan originations and general corporate purposes. As of December 31, 2022, the balance of the 2022 Term Loan was $215.0 million.
Velocity Commercial Capital, LLC is the borrower of the 2022 Term Loan, which is secured by substantially all of the borrower’s non-warehoused assets, with a guarantee from Velocity Financial, Inc., formerly Velocity Financial LLC, that is secured by the equity interests of the borrower. The syndicated corporate debt agreement contains customary affirmative and negative covenants, including financial maintenance covenants and limitations on dividends by the borrower.
As of December 31, 2022, we maintained warehouse facilities to finance our investor real estate loans and had approximately $331.7 million in outstanding borrowings with $500.1 million of available capacity under our warehouse and repurchase facilities.
37
The following table illustrates our contractual obligations existing as of December 31, 2022:
January 1, 2023 -
January 1, 2024 -
December 31, 2023
December 31, 2025
Thereafter
Total
331,740
Notes payable (corporate debt)
215,000
Leases payments under noncancelable operating leases
1,514
1,379
448
3,341
333,254
215,448
550,081
38
Off-Balance-Sheet Arrangements
At no time have we maintained any relationships with unconsolidated entities or financial partnerships, such as entities referred to as structured finance, or special-purpose or variable interest entities, established for the purpose of facilitating off-balance-sheet arrangements or other contractually narrow or limited purposes. Further, we have never guaranteed any obligations of unconsolidated entities or entered into any commitment or intent to provide funding to any such entities.
New Accounting Standards
ASU 2022-02, "Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures." The amendments in this ASU eliminate the recognition and measurement guidance for troubled debt restructuring by Creditors and require enhanced disclosures for certain loan refinancings and restructurings by creditors when a borrower is experiencing financial difficulty. ASU 2022-02 requires that an entity disclose current-period gross write-offs by year of origination for financing receivables. This ASU is effective January 1, 2023 for the Company. The adoption of this standard is not expected to have a significant impact on the Company’s consolidated financial statements.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Item 8. Financial Statements and Supplemental Data.
Our consolidated financial statements and the notes related to the financial statements, together with the independent registered public accounting firms' reports thereon, are included in Item 15. Exhibits, Financial Statements and Schedules and are filed as part of this Annual Report on Form 10-K and are incorporated herein by reference.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15(e) and 15d-15(e) under the Exchange Act as of the end of the period covered by this Annual Report. Our disclosure controls and procedures are designed to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including the Chief Executive Officer and the Chief Financial Officer, to allow timely decisions regarding required disclosures. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objective and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
Based on the evaluation of our disclosure controls and procedures as of December 31, 2022, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at a reasonable assurance level as of the end of the period covered by this report.
Management’s Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) for the Company. Our internal control over financial reporting is designed to provide reasonable assurances regarding the reliability of financial reporting and the preparation of our consolidated financial statements in accordance with U.S. generally accepted accounting principles, or GAAP, and includes those policies and procedures that:
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree or compliance with the policies or procedures may deteriorate.
Our management, with the participation of its Chief Executive Officer and Chief Financial Officer, assessed our internal control over financial reporting as of December 31, 2022, the end of our fiscal year. Management based its assessment on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and concluded that our internal control over financial reporting was effective at the reasonable assurance level as of December 31, 2022.
The effectiveness of our internal control over financial reporting as of December 31, 2022 has been audited by RSM US LLP, our independent registered public accounting firm, as stated in their attestation report, which appears herein in Item 8.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the year ended December 31, 2022, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 9B. Other Information.
Item 10. Directors, Executive Officers and Corporate Governance.
Information with respect to this item will be contained in our Proxy Statement for our 2023 Annual Meeting of Shareholders, which is incorporated herein by reference.
Item 11. Executive Compensation.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
Item 14. Principal Accounting Fees and Services.
Item 15. Exhibits and Financial Statement Schedules.
The financial statements filed as part of this Annual Report are included in Part II, Item 8 of this Annual Report.
Financial statement schedules have been omitted in this Annual Report because they are not applicable, not required under the instructions or the information requested is set forth in the financial statements or related notes thereto.
Incorporated by Reference
Exhibit
Number
Exhibit Title
Form
File No.
Filing Date
3.1
Certificate of Conversion
8-K
001-39183
1/22/2020
Restated Certificate of Incorporation of Velocity Financial, Inc.
5/23/2022
3.3
Amended and Restated Bylaws of Velocity Financial, Inc.
3/25/2022
Form of Stock Certificate for Common Stock
S-1
333-234250
10/18/2019
Form of Warrant to Purchase Common Stock
4/07/2020
4.3
Description of the Registrant’s Securities
10-K
10.1
Stockholders Agreement dated as of January 16, 2020
10.2
Registration Rights Agreement dated as of January 16, 2020
10.3
Registration Rights Agreement dated as of April 7, 2020
10.4
Securities Purchase Agreement among Velocity Financial, Inc. and the Purchasers Party thereto dated April 5, 2020
4/06/2020
Velocity Financial, Inc. Employee Stock Purchase Plan*
DEF 14A
AII
4/8/2022
10.6
Amended and Restated Velocity Financial, Inc. 2020 Omnibus Incentive Plan*
AI
Form of Nonqualified Stock Option Award Notice and Agreement under the 2020 Omnibus Incentive Plan*
S-1/A
1/6/2020
10.8
Form of Nonqualified Stock Option Award Notice and Agreement (Director Grant-IPO) under the 2020 Omnibus Incentive Plan*
Form of Nonqualified Stock Option Award Notice and Agreement (Executive Officer Grant-IPO) under the 2020 Omnibus Incentive Plan*
10.10
Form of Restricted Stock Unit Grant and Agreement (Director Grant) under the 2020 Omnibus Incentive Plan*
10.11
Form of Restricted Stock Unit Grant and Agreement (Standard Grant) under the 2020 Omnibus Incentive Plan*
10.12
Form of Restricted Stock Grant and Agreement under the 2020 Omnibus Incentive Plan*
10.13
Velocity Financial 2022 Annual Incentive Program for Messrs. Farrar, Szczepaniak and Taylor*
-
2/15/2022
10.14
Form of Equity Distribution Agreement, dated September 3, 2021
9/7/2021
10.15
Form of Officer and Director Indemnity Agreement
10.37
11/6/2019
10.16
Form of Performance Stock Unit Grant and Agreement*
10.17
Note Purchase Agreement Dated as of March 15, 2022, among Velocity Financial, Inc., Velocity Commercial Capital, LLC, U.S. Bank Trust Company, National Association, as collateral agent, and the respective purchasers of the Notes.
3/16/2022
10.18
Security Agreement, dated as of March 15, 2022, among Velocity Financial, Inc., Velocity Commercial Capital, LLC and U.S. Bank Trust Company, National Association, as collateral agent.
21.1
List of Subsidiaries of the Registrant
23.1
Consent of RSM US LLP
23.2
Consent of KPMG LLP
31.1
Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Certification of Principal Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002+
32.2
Certification of Principal Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002+
101
Interactive data files pursuant to Rule 405 of Regulation S-T, formatted in Inline XBRL: (i) the Consolidated Balance Sheets as of December 31, 2022 and 2021 (ii) the Consolidated Statements of Income for the year December 31, 2022, 2021, and 2020, (iii) the Consolidated Statements of Changes in Stockholders’ Equity for the year December 31, 2022, 2021, and 2020, (iv) the Consolidated Statements of Cash Flows for the year December 31, 2022, 2021, and 2020 and (v) the Notes to unaudited Consolidated Financial Statements.
101.INS
Inline XBRL Instance Document
101.SCH
Inline XBRL Taxonomy Extension Schema Document
101.CAL
Inline XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF
Inline XBRL Taxonomy Extension Definition Linkbase Document
101.LAB
Inline XBRL Taxonomy Extension Label Linkbase Document
101.PRE
Inline XBRL Taxonomy Extension Presentation Linkbase Document
104
Cover Page Interactive Data File (embedded within the Inline XBRL document).
* Management contract or compensatory plan or arrangement.
+ This certification is deemed not filed for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference into any filing under the Securities Act or the Exchange Act.
43
Item 16. Form 10-K Summary.
VELOCITY FINANCIAL, INC. AND SUBSIDIARIES
(FORMERLY KNOWN AS VELOCITY FINANCIAL, LLC AND SUBSIDIARIES)
Index to Consolidated Financial Statements
Reports of Independent Registered Public Accounting Firm (RSM US LLP: PCAOB ID No. 49) (KPMG LLP: PCAOB ID No. 185)
F-2
Consolidated Balance Sheets as of December 31, 2022 and 2021
F-8
Consolidated Statements of Income for the years ended December 31, 2022, 2021 and 2020
F-10
Consolidated Statements of Changes in Stockholders’ / Members’ Equity for the years ended December 31, 2022, 2021 and 2020
F-11
Consolidated Statements of Cash Flows for the years ended December 31, 2022, 2021 and 2020
F-12
Notes to Consolidated Financial Statements
F-14
F-1
Report of Independent Registered Public Accounting Firm
Stockholders and the Board of Directors of Velocity Financial, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Velocity Financial, Inc. and its subsidiaries (the Company) as of December 31, 2022 and 2021, the related consolidated statements of income, stockholders'/members’ equity and cash flows for each of the two years in the period ended December 31, 2022, and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2022, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013, and our report dated March 13, 2023, expressed an unqualified opinion on the effectiveness of the Company's internal control over financial reporting.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Emphasis of Matter
As discussed in Note 2 to the financial statements, the Company has elected to change its method of accounting to record loans originated on or after October 1, 2022, at fair value. The 2022 financial statements reflect the accounting method change. Our opinion is not modified with respect to this matter.
Critical Audit Matter
The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Valuation of allowance for loan losses – management’s assessment of forecasted economic scenarios
As described in Notes 2 and 6 to the financial statements, the Company’s allowance for loan losses totaled $4.9 million as of December 31, 2022. The allowance for loan losses is calculated under the expected credit loss model and is an estimate of life-of-loan losses for the Company’s loans held for investment.
The allowance for loan losses consists of an asset-specific component for estimating loan losses for individual loans that do not share risk characteristics with other loans and a collective pooled component for estimating loan losses for pools of loans that share similar risk characteristics. The allowance for the collective pooled component is derived from an estimate of expected loan losses primarily using an expected loss methodology that incorporates certain risk characteristics that are derived from internally developed and third-party models using the open pool method.
To determine the loss rates for the open pool method, the Company starts with its historical database of losses, segmenting the loans by loan purpose, product type and repayment period to estimate annual average loss rates. The model then adjusts the annual average loss rates for macroeconomic forecasts over a reasonable and supportable period, followed by a straight-line reversion to the historical loss rates.
Management considered multiple scenarios from different macroeconomic forecasts and selected one forecast scenario with a reasonable and supportable forecast period of eight quarters as of December 31, 2022.
The estimation of the allowance for loan losses for pools of loans that share similar risk characteristics involves many inputs and assumptions. These inputs and assumptions include, among others, the selection, evaluation and measurement of the reasonable and supportable forecast scenarios discussed above, which requires management to apply judgment and that is subject to change as forecasted economic events evolve.
We identified the determination and evaluation of the forecasted economic component of the allowance for loan losses as a critical audit matter because auditing the underlying assumptions and evaluation of the forecasts used in the allowance for loan losses involved a degree of complexity and auditor judgment.Our audit procedures related to management’s evaluation and establishment of the forecasted economic scenarios in the allowance for loan losses included the following, among others:
F-3
Accounting for loans at fair value – significant assumptions used in the valuation model that are unobservable inputs
As described in Notes 2, 6 and 26 to the financial statements, the Company has elected the fair value option to measure all loans originated on or after October 1, 2022, at fair value. As of December 31, 2022, loans held for investment, at fair value, were $276 million. The Company utilized a third-party valuation model and unobservable inputs to estimate the fair value of the loans held for investment recorded at fair value. Management determines the fair value of these loans using a discounted cash flow model that estimates future cash flows of these loans using key loan metrics and significant unobservable inputs. The significant assumptions used in the valuation model include those related to prepayment speeds, loss severity, default rates and discount rates.
We have identified the fair value of loans held for investment as a critical audit matter because of the unobservable inputs management uses to estimate fair value and the fact that the assumptions noted above could result in a significant change in the loans’ fair value measurement. Auditing the significant assumptions involved a degree of complexity, a high degree of auditor judgment and increased audit effort through the use of auditor-employed valuation specialists.
Our audit procedures related to testing management’s evaluation and establishment of significant assumptions included the following, among others:
/s/ RSM US LLP
We have served as the Company's auditor since 2021.
Los Angeles, California
March 13, 2023
F-4
Opinion on the Internal Control Over Financial Reporting
We have audited Velocity Financial, Inc. and its subsidiaries' (the Company) internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheet of the Company as of December 31 2022 and 2021, the related consolidated statements of income,, stockholders’/members’ equity and cash flows for each of the two years in the period ended December 31, 2022, and the related notes to the consolidated financial statements of the Company and our report dated March 13, 2023, expressed an unqualified opinion.
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company's assets that could have a material effect on the financial statements.
F-5
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
F-6
To the Stockholders and Board of DirectorsVelocity Financial, Inc.:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated statements of income, changes in stockholders’ / members’ equity, and cash flows of Velocity Financial, Inc. and subsidiaries (the Company) for the year ended December 31, 2020, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the results of operations of the Company and its cash flows for the year ended December 31, 2020, in conformity with U.S. generally accepted accounting principles.
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audit included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audit provides a reasonable basis for our opinion.
/s/ KPMG LLP
We served as the Company’s auditor from 2011 to 2021.
Los Angeles, CaliforniaMarch 16, 2021
F-7
CONSOLIDATED BALANCE SHEETS
December 31, 2022 and 2021
(In thousands)
ASSETS
Loans held for investment, at fair value
LIABILITIES
Warehouse and repurchase facilities, net
Commitments and contingencies
EQUITY
Common stock ($0.01 par value, 100,000,000 shares authorized; 32,523,516 and 32,293,042 shares issued, 32,489,869 and 32,293,042 shares outstanding at December 31, 2022 and 2021, respectively)
326
323
Treasury stock, at cost (33,647 common shares at December 31, 2022 and none at December 31, 2021)
(458
Additional paid-in capital
300,310
296,364
Retained earnings
76,633
44,422
Total Velocity Financial Inc. stockholders' equity
Total equity
380,500
344,490
Total liabilities and equity
See accompanying notes to consolidated financial statements.
The following table represents the assets and liabilities of our consolidated variable interest entities (in thousands):
2,968
4,713
3,108,316
2,202,010
Accrued interest and other receivables
77,191
83,493
10,380
9,861
3,198,870
2,300,086
50,169
45,705
Securities issued
2,786,459
1,957,584
F-9
CONSOLIDATED STATEMENTS OF INCOME
For the years ended December 31, 2022, 2021 and 2020
(In thousands, except per share amounts)
Unrealized gain on mortgage servicing rights
2,086
4,767
Net earnings (loss) allocated to common shareholders
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ / MEMBERS’ EQUITY
($ In thousands)
Common Stock
Treasury Stock
Members’ Equity
Shares
Par Value
AdditionalPaid-inCapital
RetainedEarnings
Amount
TotalStockholders'Equity
Non-Controlling Interest
Total Equity
Balance – December 31, 2019
$152,844
$—
Cumulative effect of change in accounting principle (1)
(96)
Class A equity units conversion
(92,650)
Class D equity units conversion
(60,194)
Issuance of common stock
20,087,494
247,539
247,740
Deemed dividends-convertible preferred stock
(46,472)
(2,483)
(48,955)
Issuance of warrants
2,158
Stock-based compensation
965
Balance – December 31, 2020
$201
$204,190
$15,198
$219,589
11,699,037
122
90,022
90,144
Restricted stock awarded and earned stock compensation
506,511
1,132
Stock-based compensation - Options
1,020
Recognition of non-controlling interest
Balance – December 31, 2021
32,293,042
$323
$296,364
$44,422
$341,109
$3,381
$344,490
Common stocks
74,009
606
607
Purchase of treasury stock at cost
(33,647)
(458)
Restricted stock awarded and stock-based compensation expenses
156,465
3,340
3,342
Balance – December 31, 2022
32,523,516
$326
$300,310
$76,633
$(458)
$376,811
$3,689
$380,500
CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
796
1,119
1,219
Amortization of right-of-use assets
1,292
1,227
Origination of loans held for sale
(31,255
(96,064
Proceeds from sales of loans held for sale
32,156
80,858
Purchase of held for sale loans
(1,500
(1,232
Repayments on loans held for sale
2,673
19,415
Net accretion of discount on purchased loans and deferred loan origination costs
7,009
6,519
4,587
Provision for (reversal of) uncollectible borrower advances
(175
(80
871
(3,699
(6,776
(6,911
Real estate acquired through foreclosure in excess of recorded investment
(3,408
(1,117
(665
Amortization of debt issuance discount and costs
28,294
20,224
16,156
Loss on disposal of property and equipment
Change in valuation of real estate owned
364
1,759
1,734
Change in valuation of fair value loans
(8,265
(29
(442
Change in valuation of held for sale loans
(17
(328
Change in valuation of mortgage servicing rights
(2,086
Gain on sale of real estate owned
(2,939
(409
(644
3,343
2,159
Deferred tax expense (benefit)
11,571
(9,950
1,667
Change in operating assets and liabilities:
(7,421
(3,287
(5,603
(8,043
(360
4,137
(2,562
16,452
11,058
Net cash provided by operating activities
Cash flows from investing activities:
Purchase of loans held for investment
(18,231
(20,586
(3,571
Origination of loans held for investment
(1,739,572
(1,344,027
(343,607
Proceeds from sales of loans originally classified as held for investment
292,472
135,787
99,601
Payoffs of loans held for investment and loans at fair value
541,676
568,837
341,971
Proceeds from sale of real estate owned
22,497
9,637
7,469
Purchase of real estate owned
(2,250
Capitalized real estate owned improvements
(194
(846
Change in advances
(5,414
(5,429
(8,709
Change in impounds and deposits
910
9,202
(3,843
Purchase of property and equipment
(326
(135
(726
Proceeds from sale of investments
1,180
Acquisition of Century, net of cash acquired
(10,755
Net cash (used in) provided by investing activities
Cash flows from financing activities:
Warehouse and repurchase facilities advances
1,687,005
1,215,971
420,196
Warehouse and repurchase facilities repayments
(1,658,065
(989,374
(766,679
Proceeds from secured financing
175,000
Repayment of secured financing
(170,844
(82,156
(75,000
Proceeds of securitizations, net
1,369,985
977,678
536,687
Repayment of securitizations
(543,620
(643,500
(398,324
Debt issuance costs
(25,594
(27,024
(8,869
Purchase of treasury stock
Net proceeds from issuance of preferred stock
41,044
Proceeds from issuance of warrants
100,800
Deferred stock issuance costs
(560
IPO deal costs
(1,903
Net cash provided by (used in) financing activities
Net increase (decrease) in cash, cash equivalents, and restricted cash
Cash, cash equivalents, and restricted cash at beginning of year
47,604
20,293
27,552
Cash, cash equivalents, and restricted cash at end of year
62,056
Supplemental cash flow information:
Cash paid during the year for interest
118,711
85,019
85,407
Cash paid during the year for income taxes
23,039
9,645
Noncash transactions from investing and financing activities:
Transfer of loans held for investment to loans held for sale
(279,233
(205,671
(110,678
Transfer of loans held for investment to real estate owned
10,031
11,466
9,747
Capitalized interest on loans held for investment
1,399
2,046
7,814
Transfer of loans held for sale to held for investment
77,190
11,137
213,609
Deferred IPO costs charged against additional paid-in capital
(4,000
Discount (premium) on issuance of securitizations
23,398
2,051
Preferred stock conversion to common stock
Business combination:
Investment securities
1,181
Fair value of tangible asset acquired
688
Mortgage servicing rights
154
Liabilities assumed
1,814
F-13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2022, 2021, and 2020
Note 1 — Organization and Description of Business
Velocity Financial, LLC (VF or the Company) was a Delaware limited liability company (LLC) formed on July 9, 2012 for the purpose of acquiring all membership units in Velocity Commercial Capital, LLC (VCC). On January 16, 2020, Velocity Financial, LLC converted from a Delaware limited liability company to a Delaware corporation and changed its name to Velocity Financial, Inc. Upon completion of the conversion, the Velocity Financial, LLC’s Class A equity units of 97,513,533 and Class D equity units of 60,193,989 were converted to 11,749,994 shares of Velocity Financial, Inc. common stock. On January 22, 2020, the Company completed its initial public offering of 7,250,000 shares of common stock at a price to the public of $13.00 per share. On January 28, 2020, the Company completed the sale of an additional 1,087,500 shares of its common stock, representing the full exercise of the underwriters’ option to purchase additional shares, at a public offering price of $13.00 per share. The Company’s stock trades on The New York Stock Exchange under the symbol “VEL”.
VCC, a California LLC formed on June 2, 2004, is a mortgage lender that originates and acquires small balance investor real estate loans, providing capital to the investor real estate loan market. The Company is licensed as a California Finance Lender and, as such, is required to maintain a minimum net worth of $250 thousand. The Company does not believe there is any potential risk of not being able to meet this regulatory requirement. The Company uses its equity capital and borrowed funds to originate and invest in investor real estate loans and seeks to generate income based on the difference between the yield on its investor real estate loan portfolio and the cost of its borrowings. The Company does not engage in any other significant line of business or offer any other products or services, nor does it originate or acquire investments outside of the United States of America.
The Company, through its wholly owned subsidiaries, is the sole beneficial owner of the Velocity Commercial Capital Loan Trusts, from the 2016-1 Trust through and including the 2022-5 Trust, all of which are New York common law trusts, with the exception of VCC 2022-MC1 Trust which is a Delaware statutory trust. The Trusts are bankruptcy remote, variable interest entities (VIE) formed for the purpose of providing secured borrowings to the Company and are consolidated with the accounts of the Company.
On December 28, 2021, the Company acquired an 80% ownership interest in Century Health & Housing Capital, LLC (“Century”). Century is a licensed Ginnie Mae issuer/servicer that provides government-insured Federal Housing Administration (FHA) mortgage financing for multifamily housing, senior housing and long-term care/assisted living facilities. Century originates loans through its borrower-direct origination channel and services the loans through its in-house servicing platform, which enables the formation of long-term relationships with its clients and drives strong portfolio retention. Century is a consolidated subsidiary of the Company as of completion of the acquisition. In addition, as a servicer of Ginnie Mae loans, Century is required to maintain a minimum net worth, and Century is in compliance with this requirement as of December 31, 2022.
Note 2 — Basis of Presentation and Summary of Significant Accounting Policies
The consolidated financial statements of the Company have been prepared on the accrual basis of accounting and in accordance with United States Generally Accepted Accounting Principles (U.S. GAAP).
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosures of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of consolidated income and expenses during the reporting period.
Principles of Consolidation
The principles of consolidation require management to determine and reassess the requirement to consolidate VIEs each reporting period, and therefore, the determination may change based on new facts and circumstances pertaining to each VIE. This could result in a material impact to the Company’s consolidated financial statements in subsequent reporting periods.
The Company consolidates the assets, liabilities, and remainder interests of the Trusts as management determined that VCC is the primary beneficiary of these entities. The Company’s ongoing asset management responsibilities provide the Company with the power to direct the activities that most significantly impact the VIE’s economic performance, and the remainder interests provide the Company with the right to receive benefits and the obligation to absorb losses, limited to its investment in the remainder interest of the Trusts.
The consolidated financial statements as of December 31, 2022 and 2021 include only those assets, liabilities, and results of operations related to the business of the Company, its subsidiaries, and VIEs.
Business Combination
The Company accounts for its business combinations using the acquisition method of accounting. Assets acquired and the liabilities assumed as part of a business combination are recognized separately from goodwill at their acquisition date fair values. Goodwill is measured as the excess of consideration transferred over the net of the acquisition date fair values of the assets acquired and the liabilities assumed. The Company, with the assistance of outside specialists as necessary, use estimates and assumptions to value assets acquired and liabilities assumed at the acquisition date as well as contingent consideration, where applicable. The Company may refine these estimates during the measurement period which may be up to one year from the acquisition date. As a result, during the measurement period, the Company records adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to the Consolidated Statements of Income.
Restricted Cash
Restricted cash consisted of the required specified reserves by the 2020-2 and 2022-MC1 Trust agreements to pay the notes on each payment date if collections on mortgage loans are insufficient to make payments on the notes, and cash held by the Company for potential future advances due certain borrowers.
Loans Held for Investment and Loans Held for Sale
Except for loans originated in accordance with the guidelines of Ginnie Mae's program, which loans are originated with the intent to sell, originated loans and purchased loans are classified as held-for-investment when management has the intent and ability to hold such loans for the foreseeable future or until maturity. Loans held for investment originated prior to September 30, 2022, are carried at amortized cost, which is the outstanding principal balance, adjusted for net deferred loan origination costs and fees and allowance for loan losses. Loans originated or acquired after September 30, 2022 are carried at fair value.
Interest income is accrued on the unpaid principal balance (UPB) at their respective stated interest rates. Generally, loans are placed on nonaccrual status when they become 90 days past due. Loans are considered past due when contractually required principal or interest payments have not been made on the due dates. When a loan is placed on nonaccrual status, the accrued and unpaid interest is reversed as a reduction of interest income and accrued interest receivable. Interest income is subsequently recognized only to the extent cash payments are received or when the loan has been placed back in accrual status. Loans are restored to accrual status when (1) the loan becomes current and none of its principal and interest is due and unpaid, and the Company expects repayment of the remaining contractual principal and interest, or (2) if the loan has been formally restructured in a manner that reasonably assures repayment and performance according to its modified terms. Under these terms, the Company requires that the borrower continues to make the full restructured principal and interest payments for six consecutive months before restoring the loan to accrual status.
F-15
The deferred loans under the Company’s forbearance program are considered current at the time of deferral, and the Company continues to accrue interest on these loans. Deferred loans that subsequently went 90 days past due after the deferral date were placed on nonaccrual status with any accrued interest income reversed through earnings. The Company evaluates the COVID-19 forbearance-granted loans on an individual basis to determine if a reserve should be established on the collectability of the unamortized cost and accrued interest, and whether any loans should be placed on nonaccrual status.
For originated loans prior to October 1, 2022, carried at amortized cost, net deferred loan origination costs are amortized to interest income using the level yield method. Loan origination fees and costs on loans originated or acquired after September 30, 2022 are expensed as incurred.
Loans are classified as held for sale when management has the intent to sell them. Loans held for sale originated prior to October 1, 2022 are carried at lower of cost or estimated fair value. Loans held for sale originated or acquired effective October 1, 2022 are carried at estimated fair value. The Century loans are considered as held for sale until they meet the sale criteria describe in the following paragraphs, which is generally when they are delivered to GNMA in exchange for GNMA securities. The Company will service the loan for Ginnie Mae.
On occasion, as part of the Company’s management strategy of the loans held in its portfolio, the Company will transfer loans from held for investment to held for sale. Upon transfer of any loans that were held at amortized cost, any associated allowance for loan loss is charged off and the carrying value of the loan is adjusted to the lower of cost or estimated fair value. The net deferred fees and costs associated with loans held for sale are deferred (not accreted or amortized to interest income) until the related loans are sold.
The Company recognizes transfers of loans as sales when it surrenders control over the loans. Control over transferred loans is deemed to be surrendered when (1) the loans have been isolated from the Company, (2) the transferee has the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred loans, and (3) the Company does not maintain effective control over the transferred loans through either (a) an agreement that entitles and obligates the Company to repurchase or redeem them before their maturity or (b) the ability to unilaterally cause the holder to return the specific loans. Gains or losses on the sale of these loans are included in “Gain on disposition of loans” in the Consolidated Statements of Income.
Interest income on loans held for sale is recognized over the life of the loans using their contractual interest rates. Income recognition is suspended, and the unpaid interest receivable is reversed against interest income when loans become 90 days delinquent, or when, in management’s opinion, a full recovery of interest and principal becomes doubtful. Income recognition is resumed when the loan becomes contractually current.
Mortgage Servicing Rights
The Company retains the servicing rights of the Ginnie Mae insured loans that are sold in the secondary market by Century. Servicing rights are initially recorded at fair value with the income statement effect recorded in gains on sale of loans.
Under the fair value measurement method, the Company measures servicing rights at fair value at each reporting date and reports changes in fair value of servicing assets in earnings in the period in which the changes occur and are included as a component of non-interest income or expense on the Consolidated Statements of Income. The fair value of servicing rights is subject to significant fluctuations as a result of changes in estimated and actual prepayment speeds and default rates and losses. Loans serviced for others are not included in the Consolidated Balance Sheet.
Servicing fee income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal or a fixed amount per loan and are recorded as income when earned.
F-16
Effective January 1, 2020, the Company adopted ASU 2016-13 Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments replacing the incurred loss accounting approach with the current expected credit loss approach for all financial assets measured at amortized cost, which as of the adoption date consisted entirely of our held for investment loan portfolio. Under the current expected credit loss ("CECL") methodology, the allowance for credit losses is measured using two components. A component that measures expected credit losses on a collective (pool) basis when similar risk characteristics exist and a component that measures expected credit losses on an individual loan basis. For the collective pool component, the Company identified the following portfolio segments based on risk characteristics of the loans in its loan portfolio (pool):
The Company determines the collectability of its loans in the collective pools by evaluating certain risk characteristics. The segmentation of its loan portfolio was determined based on analyses of its loan portfolio performance over the past nine years. Based on analyses of the loan portfolio’s historical performance, the Company concluded that loan purpose and product types are the most significant risk factors in determining its expectation of future loan losses. Loan purpose considers whether a borrower is acquiring the property or refinancing an existing property. The historical experience shows that refinance loans have higher loss rates than loans for property acquisitions. Product type includes residential 1-4 unit property and traditional commercial property. The historical experience shows that traditional commercial property loans have higher loss rates than residential 1-4 unit property. Short term loans have a maturity of one to 2 years from origination. Long term loans have a maturity of up to 30 years from origination.
F-17
The Company estimates the allowance for loan losses using relevant available information, from internal and external sources, relating to historical performance, current conditions, and reasonable and supportable macroeconomic forecasts. Historical credit loss experience provides the basis for the estimation of expected credit losses. Adjustments to historical loss information are considered for differences in current loan-specific risk characteristics such as differences in underwriting standards, portfolio mix, delinquency levels, or term, as well as for changes in environmental conditions, such as unemployment rates, property values and changes in the competitive or regulatory environment.
The Company uses an open pool loss rate methodology to model expected credit losses. To determine the loss rates for the open pool method, the Company starts with its historical database of losses, segmenting the loans by loan purpose, product type and repayment period. A third-party model applying the open pool method is used to estimate an annual average loss rates by dividing the respective pool's quarterly historical losses by the pool's respective prior quarter’s ending unamortized loan cost balance and deriving an annual average loss rate from the historical quarterly loss rates. The model then adjusts the annual average loss rates based upon macroeconomic forecasts over a reasonable and supportable period, followed by a straight-line reversion to the historical loss rates. The adjusted annual average loss rates are applied to the forecasted pool balance within each segment. The forecasted balances in the loan pool segments are calculated based on a principal amortization using contractual maturity, factoring in further principal reductions from estimated prepayments. Estimated prepayments, or Constant Prepayment Rates ("CPRs") are developed from multiple loan characteristic considerations, such as property types, FICO scores, loan purpose, and prepayment penalty terms, which is the most significant driver of prepayment activity. The prepayment penalty terms differ between the short-term and long-term loans, and the Company has developed a CPR curve for its short-term loans (2-year or less) and one for its long-term loans (30-year). Data from 2012-2022 is used to develop prepayment rates for the Company’s long-term loans. Because of the prepayment penalty structure in the Company’s long-term loans, prepayments during the active penalty term are historically low and begin to ramp up after the prepayment penalty term. The active prepayment penalty term is considered for existing and new loans over the reasonable and supportable forecast period in determining estimated prepayments. The Company back-tests the CPR curves on a quarterly basis and adjusts the CPR curves as appropriate. The reasonable and supportable period is meant to represent the period in which the Company believes the forecasted macroeconomic variables can be reasonably estimated. Significant variables or assumptions incorporated in the macroeconomic forecasts include U.S. unemployment, treasury yields, U.S. real gross domestic product (GDP), and U.S. real estate housing prices. The Company considers multiple scenarios from different macroeconomic forecasts and uses different forecast and revision periods for estimating lifetime expected credit losses.
For the December 31, 2020 CECL estimate, the Company considered a COVID-19 adverse stress scenario and a COVID-19 severe stress scenario, both with a five-quarter reasonable and supportable forecast period followed by a four-quarter straight-line reversion period. Management decided that using only the adverse stress scenario did not factor for recent additional COVID-related risks such as the post-holiday spike in infections and deaths, unknown impact of a recent mutant virus, success of the vaccine, and impact of recent Presidential executive orders. Management concluded that applying a 50% weight to the adverse and severe stress scenarios was appropriate given the status of the pandemic at year-end. The various scenarios, the weighting of scenarios, as well as the forecast period and reversion to historical loss is subject to change as conditions in the market change and the Company’s ability to forecast economic events evolves.
For the December 31, 2021 CECL estimate, the Company considered a COVID-19 severe stress scenario with a five-quarter reasonable and supportable forecast period followed by a four-quarter straight-line reversion period. The various scenarios, as well as the forecast period and reversion to historical loss is subject to change as conditions in the market change and the Company’s ability to forecast economic events evolves.
For the December 31, 2022 CECL estimate, the Company considered a severe stress scenario with an eight-quarter reasonable and supportable forecast period followed by a two-quarter straight-line reversion period. The various scenarios, as well as the forecast period and reversion to historical loss is subject to change as conditions in the market change and the Company’s ability to forecast economic events evolves.
The Company has determined that once a loan becomes nonperforming (90 or more days past due), it no longer shares the same risk characteristics of the other loans within its segment of homogeneous loans (pool). The Company pulls these loans out of the segments and evaluates the loans individually using the practical expedient to determine the credit exposure. Nonperforming loans are considered collateral dependent by the Company. Using the practical expedient, the fair value of the underlying collateral, less estimated selling costs, is compared to the carrying value of the loan in the determination of a credit loss. The allowance for loan losses
F-18
for individually assessed or evaluated loans is the difference between the fair value of the collateral underlying the loans at the reporting date, adjusted for estimated selling costs, and the amortized cost basis.
The allowance for loan losses is a valuation account that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on the loans. Loans are charged off against the allowance when the Company believes the uncollectibility of a loan balance is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off.
The allowance for loan losses is maintained at a level deemed adequate by management to provide for expected losses in the portfolio at the balance sheet date. While management uses available information to estimate its required allowance for loan losses, future additions to the allowance for credit losses may be necessary based on changes in estimates resulting from economic and other conditions.
The Company has made the accounting policy election not to measure an allowance for credit losses for accrued interest receivables. When a loan is placed on nonaccrual status, the accrued and unpaid interest is reversed as a reduction of interest income and accrued interest receivable. Accrued interest receivable is excluded from the amortized cost of loans and it is presented as accrued interest receivable in the Consolidated Balance Sheets.
Effective October 1, 2022, the Company elected to apply FVO accounting to its newly originated loans. Loans carried at fair value do not require a separate allowance for loan loss since any loan impairment will be reflected in the fair value of the loan. All loans originated or acquired prior to October 1, 2022, are carried at amortized cost and are subject to a CECL reserve.
Troubled Debt Restructurings
Troubled debt restructurings (TDRs) are renegotiated loans where borrower concessions have been granted, such as reduction of the UPB or interest rate and for which the borrower is experiencing financial difficulty. Insignificant concessions, such as short-term forbearances, do not constitute a TDR. The Company measures TDR impairment based on the present value of expected future cash flows discounted at the loan's effective interest rate, except that as a practical expedient, it may also measure impairment based on a loan's observable market price, or the fair value of the collateral less selling costs if the loan is a collateral-dependent loan. Once a loan is classified as a TDR, it remains a TDR for the purpose of calculating the allowance for credit losses for the remainder of its contractual term.
F-19
Accrued Interest and Other Receivables
Accrued interest and other receivables represent accrued and uncollected interest on loans in accrual status; principal and interest payments received, but unremitted by the servicer; and receivables from borrowers for escrow and other advances, net of an allowance for uncollectible borrower advances.
Real Estate Owned, Net (REO)
Properties acquired through foreclosure, deed in lieu of foreclosure, or from third parties that meet all of the following criteria are classified as real estate owned: (i) management has the intent to sell the property; (ii) the property is available for immediate sale in its present condition, or management intends on making necessary repairs to render the property saleable, subject only to terms that are usual and customary; and (iii) it is unlikely that any significant changes to the plan will be made or that the plan will be withdrawn.
Real estate owned is initially recorded at the property’s estimated fair value, based on appraisals or broker price opinions obtained, less estimated costs to sell, at the acquisition date, establishing a new cost basis. If the recorded loan balance at the time of transfer exceeds the estimated fair value of the property less estimated costs to sell, the charge is recorded to the allowance for loan losses. If the estimated fair value of the property less estimated costs to sell exceeds the recorded loan balance at the time of transfer, the write-up is first recorded as a recapture to the allowance for loan losses to the extent of any previous charge and then to gain on the REO. Any subsequent write-downs in the fair value of the REO after the transfer date are charged to real estate owned, net in the Consolidated Statements of Income and recognized through a valuation allowance. Subsequent increases in the fair value of the REO less selling costs reduce the valuation allowance, but not below zero, and are credited to real estate owned, net.
Property and Equipment, Net
Property and equipment is recorded at cost, less accumulated depreciation, computed principally by the straight-line method based on the estimated useful lives of the specific assets, which range from three to seven years. Software is amortized over the estimated useful lives of the specific assets, which range from three to ten years using the straight-line method. Leasehold improvements are amortized over the lives of the respective leases or the service lives of the improvements, whichever is shorter.
Goodwill arises from business combinations and is generally determined as the excess of the fair value of the consideration transferred over the fair value of the net assets acquired and liabilities assumed as of the acquisition date less any noncontrolling interest. Goodwill acquired in a purchase business combination and determined to have an indefinite useful life is not amortized but tested for impairment at least annually in the fourth quarter, or more frequently if events and circumstances exist that indicate that a goodwill impairment test should be performed.
Off Balance Sheet Credit Exposure
The Company has no off-balance-sheet assets or liabilities with credit exposure.
Income taxes are accounted for using the asset and liability method. Under this method a deferred tax asset or liability is measured based on the enacted tax rates expected to apply to taxable income in the years in which the differences between the financial statement carrying amounts and tax bases of existing assets and liabilities are expected to be recovered or settled. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date.
Valuation allowances are established to reduce the net carrying amount of deferred tax assets ("DTA") if it is determined to be more likely than not, that all or some portion of the potential deferred tax asset will not be realized.
F-20
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the DTA will or will not be realized. The Company's ultimate realization of the DTA is dependent upon the generation of future taxable income during the periods in which temporary differences become deductible. Management considers the nature and amount of historical and projected future taxable income, the scheduled reversal of deferred tax assets and liabilities, and available tax planning strategies in making this assessment. The amount of deferred taxes recognized could be impacted by changes to any of these variables.
The Company determines whether its tax positions are more likely than not to be sustained upon examination by the applicable taxing authorities, including resolution of any related appeals or litigation processes, based on the technical merits of the positions in question. Income tax positions that meet the more likely than not recognition threshold are measured to determine the amount of benefit to recognize. An income tax position is measured at the largest amount of benefit that management believes has a greater than 50% likelihood of realization upon settlement. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. The Company records interest and penalties related to unrecognized tax benefits in income tax expense.
Stock-Based Compensation
Compensation expense for stock options, and restricted stock awards is based on the fair value of the award at the date of grant. The fair value of stock options and options under the Company’s Employee Stock Purchase Plan (“ESPP”) is estimated at the date of grant using a Black-Scholes option pricing model. The fair value of restricted stock awards are determined based on the Company’s current market price on the date of grant. Under the Company’s ESPP, employees may purchase shares of common stock at a price equal to 85% of the lesser of the fair market value of the stock on the first or the last trading day of each offering period. The Company records compensation expenses related to the discount given to participating employees. Compensation expense for performance stock units is measured using the fair value at the date of grant and recorded over each vesting period, and may be adjusted over the vesting period based on interim estimates of performance against the pre-set objectives. Compensation expense for all stock-based awards is recognized in the consolidated financial statements on a straight-line basis over the requisite service period, which is generally defined as the vesting period. The Company recognizes forfeitures as they occur and the income tax effects of awards are recognized in the consolidated statements of income when awards vest or are settled.
Earnings per Share
Earnings per share are calculated utilizing the two-class method. Basic earnings per share are calculated by dividing the sum of distributed earnings to common shareholders and undistributed earnings allocated to common shareholders by the weighted average number of common shares outstanding. Diluted earnings per share are calculated by dividing the sum of distributed earnings to common shareholders and undistributed earnings allocated to common shareholders by the weighted average number of shares adjusted for the dilutive effect of stock-based awards.
Treasury shares
The Company separately presents treasury shares, which represent shares surrendered to the Company equal in value to the statutory payroll tax withholding obligations arising from the vesting of employee restricted stock awards. Treasury shares are carried at cost.
Note 3 — Current Accounting Developments
Recently Issued Accounting Standards
F-21
Note 4 — Cash, Cash Equivalents, and Restricted Cash
The Company is required to hold cash for certain Trusts and potential future advances due certain borrowers. In accordance with various mortgage servicing and related agreements, Century maintains escrow accounts for mortgage insurance premium, tax and insurance, working capital, sinking fund and other mortgage related escrows. The total escrow balances payable amounted to $68.5 million at December 31, 2022. This amount is not reflected on the balance sheet of the Company at December 31, 2022.
The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the Company’s consolidated balance sheets that sum to the total of the same such amounts shown in the consolidated statements of cash flows as of December 31, 2022, 2021, and 2020 (in thousands):
Total cash, cash equivalents, and restricted cash shown in the consolidated statements of cash flows
Note 5 — Loans Held for Sale, Net
The following table summarizes loans held for sale as of December 31, 2022 and 2021 (in thousands):
87,422
Valuation adjustments
486
There were no loans held for sale as of December 31, 2022.
Note 6 — Loans Held for Investment and Loans Held for Investment at Fair Value
The following tables summarize loans held for investment as of December 31, 2022 and 2021 (in thousands):
Loans held for
investment,
investment, at
held for
net
fair value
investment
268,632
3,277,283
Allowance for loan losses
Total loans held for investment, net
1,332
2,531,826
F-22
During the year ended December 31, 2022, $292.4 million in UPB of loans held for investment have participated in the COVID-19 forbearance program and the Company granted a 90-days forbearance period on these loans. The following table summarizes the UPB and amortized cost basis of the loans in the Company's COVID-19 forbearance program as of December 31, 2022 ($ in thousands):
Amortized Cost
295,990
Additions
Foreclosures
(3,593
(3,620
Repayments
(87,831
(89,024
203,346
Performing/Accruing
161,455
80.3%
163,346
Nonperforming/Nonaccrual
39,550
19.7%
40,000
396,918
2,616
2,615
(402
(408
(101,858
(103,135
79.8%
236,076
20.2%
59,914
F-23
Since April 1, 2020, the inception of the COVID-19 forbearance program, the Company has modified $409.6 million in UPB of loans, which includes capitalized interest of $11.5 million. As of December 31, 2022, $215.8 million in UPB of modified loans has been paid down, which includes $4.3 million of capitalized interest received.
Approximately 80.3% and 79.8% of the COVID forbearance loans in UPB were performing, and 19.7% and 20.2% were on nonaccrual status as of December 31, 2022 and 2021, respectively.
As of December 31, 2022 and 2021, the gross unpaid principal balance of loans held for investment pledged as collateral for the Company’s warehouse facility agreements, and securitizations issued were as follows (in thousands):
The 2013 repurchase agreement
170,185
202,511
The 2021 repurchase agreement
101,024
114,072
The Bank credit agreement
39,087
30,959
The 2021 term repurchase agreement
104,594
53,217
The July 2021 term repurchase agreement
3,859
Total pledged loans
418,749
400,759
2015-1 Trust
31,931
2016-1 Trust
39,720
52,623
2017-2 Trust
67,048
94,809
2018-1 Trust
48,139
71,051
2018-2 Trust
104,791
154,974
2019-1 Trust
104,249
144,727
2019-2 Trust
91,025
132,358
2019-3 Trust
75,618
103,266
2020-1 Trust
144,913
189,547
2020-2 Trust
81,259
98,403
2020-MC1 Trust
134,957
2021-1 Trust
208,875
249,396
2021-2 Trust
172,144
198,039
2021-3 Trust
178,861
202,138
2021-4 Trust
275,741
314,547
2022-1 Trust
262,526
2022-2 Trust
245,339
2022-MC1 Trust
97,246
2022-3 Trust
299,638
2022-4 Trust
326,627
2022-5 Trust
251,288
3,075,047
2,172,766
F-24
The following tables present the amortized cost basis, or recorded investment, of the Company’s loans held for investment, excluding loans carried at fair value, that were nonperforming and on nonaccrual status as of December 31, 2022 and 2021. Also included in the tables below is a TDR individually evaluated for allowance for loan loss.
Total Nonaccrual
Nonaccrual with No Allowance for Loan Loss
Nonaccrual with Allowance for Loan Loss
Allowance for Loans Individually Evaluated
% of Allowance to Total Nonaccrual/ Impaired Loans
Commercial - Purchase
22,571
22,437
134
Commercial - Refinance
87,133
82,330
4,803
Residential 1-4 Unit - Purchase
27,984
27,516
468
118
Residential 1-4 Unit - Refinance
113,909
111,742
2,167
175
Short Term 1-4 Unit - Purchase
8,140
Short Term 1-4 Unit - Refinance
35,602
30,612
4,990
258
2.1
295,339
282,777
12,562
1,096
Performing troubled debt restructuring:
17,260
16,501
759
85,935
79,131
6,804
826
17,385
17,128
257
96
107,552
105,515
2,037
138
2,986
2,881
45,300
41,870
3,430
306
2.3
276,418
263,026
13,392
1,406
Troubled debt restructuring includedin nonaccrual loans:
165
The Company has made the accounting policy election not to measure an allowance for credit losses for accrued interest receivables. The Company has also made the accounting policy election to write off accrued interest receivables by reversing interest income when loans are placed on nonaccrual status, or 90 days or more past due, other than the COVID-19 forbearance-granted loans. Any future payments received for these loans will be recognized on a cash basis.
F-25
The Company continues to evaluate the COVID-19 forbearance-granted loans on an individual basis to determine if a reserve should be established on the collectability of the accrued interest and whether any loans should be placed on nonaccrual status at a future date.
The following table presents the amortized cost basis in the loans held for investment as of December 31, 2022 and 2021, and the amount of accrued interest receivables written off by reversing interest income by portfolio segment for the years ended December 31, 2022 and 2021 (in thousands):
Interest Reversal
701,408
(640
509,421
(346
907,097
(1,343
783,260
(1,176
588,433
(596
408,770
(209
939,305
(1,602
730,321
(1,474
69,884
(189
28,989
(821
71,157
(502
71,065
(653
3,277,284
(4,872
(4,679
For the years ended December 31, 2022 and 2021, cash basis interest income recognized on nonaccrual loans was $27.3 million and $31.2 million, respectively. Other than loans in the Company's COVID-19 forbearance program, no accrued interest income was recognized on nonaccrual loans for the years ended December 31, 2022 and 2021. The average recorded investment of individually evaluated loans, computed using month-end balances, was $269.4 million and $311.2 million for the years ended December 31, 2022 and 2021, respectively. There were no commitments to lend additional funds to debtors whose loans have been modified as of December 31, 2022 and 2021.
F-26
The following tables present the activity in the allowance for loan losses for the years ended December 31, 2022 and 2021 (in thousands):
Residential
Short Term
Commercial
1-4 Unit
Purchase
Refinance
Balance - January 1, 2022
385
2,144
400
948
401
(88
149
429
(22
283
(147
(25
(7
(105
(237
639
2,031
542
1,272
388
Allowance related to:
Loans individually evaluated
Loans collectively evaluated
611
424
1,097
130
3,797
Amortized cost related to:
678,837
819,964
560,449
825,396
61,744
35,555
2,981,945
F-27
Balance - January 1, 2020
373
2,093
333
1,216
595
1,235
164
(60
(538
(116
(142
(113
(37
(208
(14
(777
376
1,318
811
2,856
492,161
697,326
391,385
622,768
26,003
25,765
2,255,408
A credit quality indicator is a statistic used by the Company to monitor and assess the credit quality of loans held for investment, excluding loans held for investment at fair value. The Company monitors its charge-off rate in relation to its nonperforming loans as its credit quality indicator. The charge-offs over the average nonperforming loans were 0.20%, 0.42%, and 0.65% for the years ended December 31, 2022 , 2021 and 2020, respectively. The recovery rates on long-term nonperforming assets were 106.7%, 104.2% and 103.1% for the years ended December 31, 2022 , 2021 and 2020, respectively. On short-term nonperforming assets, the recovery rates were 107.0% and 102.7% for the years ended December 31, 2022 and 2021, respectively. Short-term loans were classified as held for sale during the year ended December 31, 2020.
F-28
Other credit quality indicators include aging status and accrual status. Nonperforming loans are loans that are 90 or more days past due, in bankruptcy, in foreclosure, or not accruing interest. The following tables present the aging status of the amortized cost basis in the loans held for investment portfolio, which include $203.3 million and $296.0 million loans in the Company’s COVID-19 forbearance program as of December 31, 2022 and 2021, respectively (in thousands):
30–59 days
60–89 days
90+days
past due
past due(1)
loans
865
21,706
4,415
5,943
76,619
86,977
156
590
592
26,802
1,715
2,728
109,466
176
7,964
657
34,945
Total loans individually evaluated
8,418
9,263
277,502
295,183
24,899
5,096
29,995
648,842
41,711
20,561
62,272
757,692
22,840
13,948
36,788
523,661
64,925
23,224
88,149
737,247
21,273
294
21,567
40,177
5,550
1,191
6,741
28,814
Total loans collectively evaluated
181,198
64,314
245,512
2,736,433
189,616
73,577
540,695
2,736,589
700
2,314
14,246
4,464
6,818
74,488
85,770
682
16,703
807
1,088
105,657
1,224
1,762
615
1,010
43,675
7,810
11,912
256,531
276,253
17,319
4,034
21,353
470,808
31,769
7,025
38,794
658,532
14,905
5,580
20,485
370,900
9,548
48,593
574,175
21,412
217
21,629
4,374
4,060
5,561
9,621
16,144
128,510
31,965
160,475
2,094,933
136,320
43,877
436,728
2,095,098
F-29
The following table presents the aging of the amortized cost basis of loans held for investment in the Company's COVID-19 forbearance program as of December 31, 2022 and 2021(in thousands):
2,880
767
186
16,194
17,147
10,039
180
8,359
8,539
947
38,867
1,682
656
2,338
22,323
24,661
5,874
3,786
9,660
62,699
72,359
2,346
1,036
3,382
7,277
10,659
4,118
5,657
30,178
35,835
19,832
33,852
7,017
40,869
122,477
34,799
7,203
80,869
163
1,622
4,259
6,044
2,820
18,520
21,340
3,045
22,670
99
404
299
5,833
6,536
666
4,741
54,507
2,209
1,158
3,367
30,904
34,271
8,309
2,444
10,753
90,040
100,793
315
231
18,321
18,867
4,086
319
4,405
48,314
52,719
20,869
761
21,630
942
5,091
2,705
7,796
36,730
8,301
45,031
191,045
37,396
13,042
104,945
F-30
In addition to the aging status, the Company also evaluates credit quality by accrual status. The following tables present the amortized cost in loans held for investment, excluding loans held for investment at fair value, based on accrual status and by loan origination year as of December 31, 2022 and 2021 (in thousands).
Term Loans Amortized Cost Basis by Origination Year
December 31, 2022:
Pre-2018
Payment performance
Performing
273,950
249,100
36,064
56,322
33,193
30,208
Nonperforming
6,959
1,579
5,809
3,205
3,745
Total Commercial - Purchase
275,224
256,059
37,643
62,131
36,398
33,953
263,754
210,898
55,795
103,633
93,161
92,723
9,012
11,801
3,855
23,423
20,408
18,634
Total Commercial - Refinance
272,766
222,699
59,650
127,056
113,569
111,357
249,625
227,235
10,710
31,685
18,891
22,303
7,281
10,107
2,165
2,313
1,553
4,565
Total Residential 1-4 Unit - Purchase
256,906
237,342
12,875
33,998
20,444
26,868
338,959
285,195
24,703
84,208
39,870
52,461
21,391
25,023
6,907
27,746
15,834
17,008
Total Residential 1-4 Unit - Refinance
360,350
310,218
31,610
111,954
55,704
69,469
40,967
944
15,659
4,174
1,287
5,212
995
Total Short Term 1-4 Unit - Purchase
42,254
6,156
16,654
4,716
786
1,221
10,545
18,245
4,805
Total Short Term 1-4 Unit - Refinance
36,341
Total Portfolio
1,243,841
1,033,695
168,977
358,100
231,024
241,647
F-31
December 31, 2021:
2017
Pre-2017
277,618
45,836
81,541
46,637
24,164
16,365
288
1,781
5,541
4,180
3,539
1,931
277,906
47,617
87,082
50,817
27,703
18,296
239,688
64,966
144,017
118,735
62,374
67,545
697,325
2,482
3,949
26,012
26,869
16,492
10,131
242,170
68,915
170,029
145,604
78,866
77,676
263,180
12,878
48,930
29,544
12,863
23,990
1,372
2,749
3,896
3,736
3,487
2,145
264,552
15,627
52,826
33,280
16,350
26,135
343,199
31,334
114,145
59,825
31,774
42,491
11,646
6,040
31,816
30,626
16,677
10,747
354,845
37,374
145,961
90,451
48,451
53,238
730,320
1,890
15,582
8,531
1,565
1,316
9,847
1,448
11,991
12,326
1,038
15,819
22,618
5,825
2,486
27,810
34,944
1,143,849
214,490
500,689
326,082
171,370
175,345
2,531,825
F-32
Note 7 — Mortgage Loans on Real Estate
The following tables present the Company’s loans (UPB) collateralized by real estate as of December 31, 2022 and 2021 (in thousands).
Description
InterestRate
FinalMaturityDate
UnpaidPrincipalBalance(1) (2)
Nonaccrual UnpaidPrincipalBalance
1-4 unit residential (3)
Under $1.0 million
4.0% - 13.5%
January 1, 2053
1,374,726
127,125
$1.0 million and over
4.0% - 11.5%
476,813
57,508
1,851,539
184,633
Traditional commercial (4)
4.0% - 13.7%
1,196,378
69,763
4.0% - 11.7%
464,569
38,393
1,660,947
108,156
Total at December 31, 2022
January 1, 2052
987,069
127,214
325,025
44,426
1,312,094
171,640
3.1% - 13.0%
969,599
73,039
4.0% - 10.2%
305,528
28,421
1,275,127
101,460
Total at December 31, 2021
The following table presents the reconciliation of the UPB of mortgage loans for the years ended December 31, 2022, 2021, and 2020:
Balance at beginning of period
2,587,220
2,059,344
Addition during period:
New mortgage loans
435,037
Acquisition
17,657
4,643
Capitalized Interest
1,604
2,045
Deduction during period:
Collection of principal
(525,986
(568,081
(374,576
Collection of capitalized interest
(2,155
(2,163
(10,031
(11,603
(10,781
Mortgages sold
(317,676
(126,494
(176,677
Balance at end of period
F-33
Note 8 — Receivables Due From Servicers
The following tables summarize receivables due from servicers as of December 31, 2022 and 2021 (in thousands):
Warehouse and repurchase facilities and other
Loan principal payments due from servicers
24,400
664
25,064
Other loan servicing receivables
13,095
2,521
15,616
Loan servicing receivables
37,495
3,185
40,680
Corporate and escrow advances receivable
21,995
2,969
24,964
Total receivables due from servicers
59,490
6,154
42,344
1,165
43,509
10,718
11,448
53,062
1,895
54,957
17,884
1,489
19,373
70,946
3,384
Note 9 — Property and Equipment, Net
As of December 31, 2022 and 2021, property and equipment consisted of the following (in thousands):
Furniture
927
885
Computer equipment
986
1,222
Office equipment
409
278
Leasehold improvements
578
Capitalized software
6,671
7,634
Building
685
10,256
11,282
Accumulated depreciation and amortization
(6,900
(7,452
During the years ended December 31, 2022, 2021 and 2020, depreciation and amortization expense was $0.8 million, $1.1 million, and $1.2 million, respectively.
The Company engaged a third-party consulting firm to assist in the building and implementation of a data warehouse and loan origination systems. The data warehouse was placed into service in 2017 and the loan origination system was placed into service in 2018. The total capitalized costs for the data warehouse and loan origination systems (LOS) were $5.7 million as of December 31, 2022 and 2021. Total accumulated depreciation and amortization included accumulated amortization on the data warehouse and the LOS of $4.1 million and $3.7 million as of December 31, 2022 and 2021, respectively. The estimated aggregate amortization expense related to capitalized software for each of the next five years is $0.4 million for 2023, 2024, 2025, 2026, and $0.2 million for 2027.
F-34
Note 10 — Real Estate Owned, Net
The Company’s real estate owned activities were as follows during the years ended December 31, 2022 and 2021 (in thousands):
13,439
12,583
Capitalized improvements
194
Sales
(19,558
(9,228
Other adjustments
2,250
(363
(1,759
The following table summarizes information about real estate operating income and expenses, realized gains and losses on sales of real estate, and unrealized gains and losses resulting from adjustments to valuation allowances for the years ended December 31, 2022, 2021 and 2020 (in thousands):
Operating income
275
451
444
(2,781
(2,251
(2,010
(1,734
Net gain on sales of real estate
2,939
644
70
(3,150
(2,656
Net gain (loss) on sales of real estate represents the difference between the net proceeds from the liquidation of the underlying properties and their respective carrying values. The following table provides additional information about the number of properties sold and the gross gains and losses recognized in real estate owned, net, in the consolidated statements of income, during the years ended December 31, 2022, 2021 and 2020 (in thousands, except properties sold):
Gain
sold
(loss)
Sales resulting in gains
3,401
972
837
Sales resulting in losses
(462
(563
(193
Note 11 — Mortgage Servicing Rights
Mortgage loans serviced for others are not included in the consolidated balance sheets. The unpaid principal balance of mortgage loans serviced for others by Century amounted to $491.9 million and $520.6 million as of December 31, 2022 and 2021, respectively. The Company has elected to record its mortgage servicing rights using the fair value measurement method. Significant assumptions used in determining the fair value of servicing rights as of December 31, 2022 and 2021 include: 1) Weighted average discount rate of 8.1% and 8.0%, and 2) Weighted average constant prepayment rate of 6.3% and 3.2%.
The following table presents the Company's mortgage servicing rights (in thousands):
Balance at the beginning of year
Mortgage servicing rights acquired
Fair value adjustments
Balance at end of year
F-35
Note 12 — Goodwill
FASB ASC 350, Intangibles - Goodwill and Other, requires a company to perform an impairment test on goodwill annually, or more frequently if events or changes in circumstance indicate that the asset might be impaired, by comparing the fair value of such goodwill to its recorded or carrying amount. If the carrying amount of goodwill exceeds the fair value, an impairment charge must be recorded in an amount equal to the excess. The goodwill was recorded as part of the purchase accounting of Century on December 28, 2021, Management has assessed goodwill and concluded that no impairment existed as of December 31, 2022.
The following table presents the activity for goodwill (in thousands):
Goodwill acquired
Note 13 — Other Assets
Other assets were comprised of the following as of December 31, 2022 and 2021 (in thousands):
Prepaid expenses
1,843
1,628
Interest-only strips and deposits
166
Deferred costs
501
502
Income tax receivable
Operating leases - right of use assets, net
2,424
3,744
Appraisal fees for loans in process
(58
479
338
Total other assets
Note 14 — Leases
The Company adopted ASU 2016-02, Leases (Topic 842) and all subsequent related ASUs using the alternative transition method effective January 1, 2019. The Company has elected the package of practical expedients that permits the Company to not reassess prior conclusions about lease identification, lease classification and initial direct costs. The Company also elected all the new standard’s available transition practical expedients, including the short-term lease recognition exemption that includes not recognizing right-of-use (“ROU”) assets or lease liabilities for existing short-term leases, and the practical expedient to not separate lease and non-lease components for all leases.
The Company determines if a contract arrangement is a lease at inception. The Company primarily enters into operating lease contracts for office space and certain equipment. As part of the property lease agreements, the Company may include options to extend or terminate the lease when it is reasonably certain that the Company will exercise those options. The ROU lease asset also includes any lease payments made and lease incentives. Lease expense for lease payments is recognized on a straight-line basis over the lease term. The Company does not possess any leases that have variable lease payments or residual value guarantees.
The Company uses its incremental borrowing rates to determine the present value of its lease liabilities. The weighted average borrowing rate was 5.88%, 5.86%, and 6.01% as of December 31, 2022, 2021, and 2020, respectively. The Company’s leases have remaining terms ranging from 2 years to 5 years, and the weighted average remaining lease term was 2.0 years as of December 31, 2022. Short-term leases (initial term of less than 12 months) are not recorded on the balance sheet and lease expense is recognized on a straight-line basis over the lease term.
F-36
As of December 31, 2022 and 2021, operating lease ROU assets included in other assets was $2.4 million and $3.7 million, respectively. Operating lease liabilities included in accounts payable and accrued expenses was $2.7 million and $4.0 million as of December 31, 2022 and 2021, respectively. Operating lease expense is a component of “Rent and occupancy” expense on the consolidated statements of income. Operating lease expense was $1.7 million, $1.8 million, and $1.5 million for the year ended December 31, 2022, 2021, and 2020, respectively, and included short-term leases that were immaterial.
The following table presents supplemental cash flow information related to leases for the years ended December 31, 2022, 2021, and 2020 (in thousands):
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases
1,632
1,626
1,524
ROU assets obtained in exchange for lease obligations:
Operating leases
256
The following table presents maturities of operating lease liabilities as of December 31, 2022 (in thousands):
Operating Leases
2023
2024
1,209
2025
170
2026
2027
53
290
Total lease payments
Less: Imputed interest
(691
Present value of lease liabilities
2,650
F-37
Note 15 — Securitizations, Net
As of December 31, 2022, the Company is the sole beneficial interest holder of twenty-one Trusts, which are variable interest entities included in the consolidated financial statements. The securitization transactions are accounted for as secured borrowings under U.S. GAAP. The securities are subject to redemption by the Company when the stated principal balance is less than a certain percentage, ranging from 10%–30% of the original stated principal balance of loans at issuance. As a result, the actual maturity dates of the securities issued could be earlier than their respective stated maturity dates. The following table summarizes securities issued, ownership retained by the Company at the time of the securitization, and as of December 31, 2022 and 2021, and the stated maturity for each outstanding securitization (in thousands):
Securities Retained as of
Trusts
SecuritiesIssued
IssuanceDate
Stated MaturityDate
285,457
27,372
15,526
July 2045
319,809
38,792
17,541
17,633
April 2046
245,601
12,927
2,697
4,064
October 2047
176,816
9,308
2,065
2,849
April 2048
307,988
16,210
4,352
6,608
October 2048
235,580
12,399
4,178
6,180
March 2049
207,020
10,901
4,007
5,922
July 2049
154,419
8,127
3,281
4,799
October 2049
248,700
6,746
8,678
February 2050
96,352
32,118
12,847
June 2050
179,371
96,585
108,891
July 2050
251,301
13,227
10,120
12,518
May 2051
194,918
10,260
August 2051
204,205
October 2051
319,116
December 2051
273,594
5,015
4,718
February 2052
241,388
11,202
11,170
March 2052
84,967
40,911
44,038
May 2047
296,323
18,914
18,587
May 2052
308,357
25,190
25,027
July 2052
188,754
65,459
65,141
October 2052
4,820,036
468,076
236,515
206,515
F-38
The following table summarizes outstanding bond balances for each securitization as of December 31, 2022 and 2021 (in thousands):
17,536
22,369
36,401
59,183
86,497
43,596
62,375
93,792
143,152
91,167
132,306
82,508
122,205
67,899
95,521
136,643
174,550
60,445
80,676
35,711
196,969
236,190
170,072
197,744
178,038
202,793
273,489
315,489
256,667
233,045
54,528
280,066
301,856
186,577
Total outstanding bond balance
2,788,909
1,939,146
The securities and certificates are typically issued at a discount to par, which is recorded as a contra liability to the securities issued. The discount is amortized as an adjustment of yield over the stated term of the securities adjusted for prepayments. As of December 31, 2022 and 2021, unamortized discounts or premiums associated with the Trusts are as follows (in thousands):
(150
84
1,692
2021-Trust
162
214
660
925
642
838
3,546
3,665
6,161
4,878
Total unamortized discounts (premiums)
21,527
4,273
F-39
Professional and other capitalized issuance costs associated with the securitizations are recorded as a contra liability to the securities issued. As of December 31, 2022 and 2021, capitalized issuance costs associated with the Trusts are as follows (in thousands):
52
535
808
303
561
908
1,371
687
1,385
866
1,325
675
1,042
1,351
2,032
369
847
380
1,978
2,897
1,924
2,757
2,178
3,055
3,177
4,449
877
3,679
3,303
2,349
Total capitalized issuance costs
31,092
22,994
As of December 31, 2022 and 2021, the weighted average rate on the sold securities and certificates for the Trusts are as follows:
7.22
8.59
3.92
3.37
4.05
4.04
4.46
4.39
4.06
4.02
3.46
3.44
3.25
3.26
2.82
4.60
4.45
4.42
1.73
2.02
2.28
2.44
2.45
3.20
3.11
3.93
5.07
6.91
5.67
6.23
7.10
F-40
Note 16 — Other Debt
The secured financing and warehouse facilities are utilized to finance the origination and purchase of commercial real estate mortgage loans. Warehouse facilities are designated to fund mortgage loans that are purchased and originated within specified underwriting guidelines. These lines of credit fund less than 100% of the principal balance of the mortgage loans originated and purchased, requiring the use of working capital to fund the remaining portion.
On February 5, 2021, the Company entered into a five-year $175.0 million syndicated corporate debt agreement, the (“2021 Term Loan”). The 2021 Term Loan bore interest at a rate equal to one-month LIBOR plus 8.00% with a 1.00% LIBOR floor and was set to mature on February 4, 2026. As of December 31, 2021, the balance of the 2021 Term Loan was $170.8 million. The balance in the consolidated balance sheets is net of debt issuance costs and discounts of $8.0 million as of December 31, 2021.
On March 15, 2022, the Company entered into a five-year $215.0 million syndicated corporate debt agreement (“the 2022 Term Loan”). The 2022 Term Loan bears interest at a fixed rate of 7.125% and matures on March 15, 2027. Interest on the 2022 Term Loan is paid every six months. A portion of the net proceeds from the 2022 Term Loan was used to redeem all the amounts owed pursuant to the 2021 Term Loan. The remaining portion of the net proceeds from the 2022 Term Loan is used for loan originations and general corporate purposes. As of December 31, 2022, the balance of the 2022 Term Loan was $215.0 million. The balance in the consolidated balance sheets is net of debt issuance costs of $5.2 million as of December 31, 2022. The 2022 Term Loan is secured by substantially all assets of the Company not otherwise pledged under a securitization or warehouse facility and contains certain reporting and financial covenants. Should the Company fail to adhere to those covenants, the lenders have the right to demand immediate repayment that may require the Company to sell the collateral at less than the carrying amounts. As of December 31, 2022, the Company was in compliance with all covenants.
On January 4, 2011, Century entered into a Master Participation and Facility Agreement with a bank (“the 2011 Facility Agreement”). The Facility Agreement has a current extended maturity date of July 31, 2023, and is a short-term borrowing facility, collateralized by performing loans, with a maximum capacity of $60.0 million, and bears interest at one-month Secured Overnight Financing Rate (“SOFR”) plus 1.60% with a 0.25% floor. The effective interest rate was 5.6% for the year ended December 31, 2022.
On August 8, 2016, Century entered into a Promissory Note Revolving Credit Line with a bank (“Revolving Credit Line”). The Revolving Credit Line has a current extended maturity date of July 31, 2023, and is a short-term unsecured borrowing line, with a maximum capacity of $3.0 million, and bears interest at SOFR plus 2.00% with a 0.25% floor.
On May 17, 2013, the Company entered into a Repurchase Agreement (“the 2013 Repurchase Agreement”) with a warehouse lender. The 2013 Repurchase Agreement is a modified mark-to-market agreement and has a current maturity date of September 29, 2023, and is a short-term borrowing facility, collateralized by a pool of performing loans, with a maximum capacity of $300.0 million, and bears interest at SOFR plus 3.50%. All borrower payments on loans financed under the warehouse repurchase facility are first used to pay interest on the facility. The effective interest rates were 5.7% and 4.2%, for the years ended December 31, 2022 and 2021, respectively.
On September 12, 2018, the Company entered into a three-year non-mark to market secured revolving loan facility agreement (“the Bank Credit Agreement”) with a bank. The Bank Credit Agreement has a current extended maturity date of November 10, 2025. During the borrowing period, the Company can take loan advances from time to time subject to availability. Each loan advance bears interest at SFOR plus 3.61%, with a floor of 4.25%. The maximum loan amount under this facility is $50.0 million. The effective interest rates were 5.8% and 7.3% for the years ended December 31, 2022 and 2021, respectively.
F-41
On December 26, 2019, the Company entered into a $3.0 million loan agreement (“the 2019 Loan”) with a lender. The 2019 Loan is secured by five real properties acquired by the Company through foreclosure or by deed-in lieu of foreclosure. The 2019 Loan bore a fixed interest rate of 9.5%, with an extended maturity date of June 1, 2022. This loan was paid off in March 2022. The effective interest rate was 10.5% for the years ended December 31, 2022 and 2021.
On January 29, 2021, the Company entered into a non-mark-to-market Repurchase Agreement (“the 2021 Repurchase Agreement”) with a warehouse lender. The 2021 Repurchase Agreement has a current extended maturity date of April 14, 2023, and was a short-term borrowing facility, collateralized by a pool of loans, with a maximum capacity of $200.0 million, and bore interest at SOFR plus a margin of 3.50% during the availability period and 4.50% during the amortization period. All borrower payments on loans financed under the warehouse repurchase facility are first used to pay interest on the facility. The effective interest rates were 6.4% and 5.9% for the years ended December 31, 2022 and 2021, respectively.
On April 16, 2021, The Company entered into a non-mark-to-market Term Repurchase Agreement (“the 2021 Term Repurchase Agreement”) with a warehouse lender. The 2021 Term Repurchase Agreement has a maturity date of April 16, 2024, with a borrowing period through April 16, 2023. During the borrowing period, the Company can take loan advances from time to time subject to availability. Each loan advance bears interest at one-month LIBOR plus 3.0% per annum. The maximum capacity under this facility is $100.0 million. There was no balance outstanding for the year ended December 31, 2022. The effective interest rates were 5.6% and 3.5% for the years ended December 31, 2022 and December 31, 2021, respectively.
On July 29, 2021, the Company entered into a non-mark-to-market Term Repurchase Agreement (“the July 2021 Term Repurchase Agreement”) with a warehouse lender. The July 2021 Term Repurchase Agreement has a maturity date of July 29, 2024, with an option to extend the term to July 29, 2025. During the borrowing period, the Company can take loan advances from time to time subject to availability. Each loan advance bears interest at one-month LIBOR with a 0.5% floor plus 4.5% per annum. The maximum capacity under this facility is $100.0 million. The effective interest rates were 10.0% and 3.5% for the years ended December 31, 2022 and 2021, respectively.
On October 7, 2022, the Company entered into a $10.2 million short-term repurchase agreement ("the October 2022 Repurchase Agreement) with the 2013 Repurchase Agreement warehouse lender. The October Repurchase Agreement had a maturity date of January 5, 2023 and bore interest at SOFR plus 1.58%. The maturity date has been extended to March 31, 2023 and the borrowing amount has increased to $15.0 million. The maximum capacity under this agreement was $18.8 million. The effective interest rate was 6.1% for the year ended December 31, 2022.
Certain of the Company’s loans are pledged as security under the warehouse repurchase facilities and the revolving loan facility, which contain covenants. Should the Company fail to adhere to those covenants or otherwise default under the facilities, the lenders have the right to terminate the facilities and demand immediate repayment that may require the Company to sell the collateral at less than the carrying amounts. As of December 31, 2022 and 2021, the Company was in compliance with all covenants.
F-42
The following table summarizes the maximum borrowing capacity and current gross balances outstanding for the Company’s warehouse facilities and loan agreements as of December 31, 2022 and 2021 (in thousands):
Period endbalance (1)
Maximumborrowingcapacity
74,334
100,000
41,636
79,504
200,000
82,580
2,185
136,165
300,000
153,499
29,495
50,000
22,385
The 2019 loan agreement
2,700
3,000
The October 2022 repurchase agreement
10,057
18,818
The September 2022 term repurchase agreement
60,000
Revolving credit line
831,818
302,800
653,000
The following table provides an overview of the activity and effective interest rate for the years ended December 31, 2022, 2021, and 2020 ($ in thousands):
Warehouse and repurchase facilities:
Average outstanding balance
299,060
168,098
Highest outstanding balance at any month-end
426,959
336,775
439,547
Effective interest rate (1)
5.84
The following table provides a summary of interest expense that includes debt issuance cost amortization, interest, amortization of discount, and deal cost amortization for the years ended December 31, 2022, 2021, and 2020 (in thousands):
Total interest expense
Note 17 — Income Taxes
The Company elected to be treated as a corporation, for tax purposes, effective January 1, 2018. As a result, the Company calculated its deferred tax balance as of January 1, 2018 and, per U.S. GAAP, recognized a deferred tax liability of $5.5 million with a corresponding increase to income tax expense in January 2018, the period in which the change was made.
F-43
The following table details the Company’s income tax expense (benefit) (in thousands):
Current tax expense (benefit):
Federal
(90
15,042
4,454
State
552
5,477
(769
Total current tax expense
462
20,519
3,685
Deferred tax expense (benefit):
8,553
(7,362
564
3,018
(2,588
1,103
Total deferred tax expense (benefit)
Total income tax expense
The following table contains a reconciliation of the Company’s provision for income taxes at the federal statutory tax rate to the provision for income taxes at the effective tax rate as of December 31, 2022, 2021, and 2020:
Federal income tax provision at statutory rate
21.0
State income taxes, net of federal tax benefit
5.6
Permanent items
Federal true-ups
Tax credits
(0.3
(0.2
(0.4
Change in unrecognized tax benefit
(7.9
Other
1.2
Effective tax rate
27.2
26.6
The changes in state income taxes and unrecognized tax benefit in the reconciliation are primarily due to changes in state apportionment and the related valuation impacts on taxes payable as well as the deferred tax asset in the prior year.
F-44
The tax effects of temporary differences that give rise to deferred tax assets and deferred tax liabilities as of December 31, 2022 and 2021 are presented below (in thousands):
Deferred tax assets:
REMIC book-tax basis difference
10,433
Net operating loss
8,451
Mark-to-market on loans
7,066
Lease liability
783
1,151
Stock compensation
1,485
888
Accrued vacation
Intangibles
REO
225
Deferred state taxes
696
82
Gross deferred tax assets
12,212
20,078
Deferred tax liabilities:
(4,941
Right-of-use assets
(717
(1,064
Deferred origination costs
(138
(1,306
Property and equipment
(595
(710
(30
(394
MSR valuation
(758
Gross deferred tax liabilities
(7,179
(3,474
Total net deferred tax asset
The Company’s main temporary difference is due to the difference between the U.S. income tax and U.S. GAAP treatment with respect to its REMIC securities. For tax purposes, the issuances are considered taxable sales; whereas, for U.S. GAAP purposes, the REMIC issuances are considered financings.
Federal net operating loss ("NOL") carryforwards of $6.4 million generated after 2017 are available to offset future U.S. federal taxable income over an indefinite period. State NOL carryforwards totaling $2.0 million are available to offset future taxable income and began to expire in 2027. NOL carryforward periods for the various states jurisdictions generally range from 5 to 20 years.
The Company had no valuation allowance as of December 31, 2022 and 2021. Based on the Company’s estimates of taxable income over the years in which the items giving rise to the deferred tax assets are deductible, management believes it is more likely than not the Company will realize the benefits of these deductible differences.
The Company files tax returns as prescribed by the tax laws of the jurisdictions in which it operates. In the normal course of business, the Company is subject to examination by federal, state, and local jurisdictions, where applicable. As of December 31, 2022, the Company is no longer subject to U.S. tax examinations for years before 2019 and is no longer subject to state tax examinations for years before 2018.
The Company periodically reviews its income tax positions based on tax laws and regulations and financial reporting considerations, and records adjustments as appropriate. This review takes into consideration the status of current taxing authorities' examinations of the Company's tax returns, recent positions taken by the taxing authorities on similar transactions, if any, and the overall tax environment.
The Company had gross unrecognized tax benefits in the amount of $1.9 million recorded as of December 31, 2022 and 2021. If recognized, $1.5 million of the unrecognized tax benefit would affect the 2022 annual effective tax rate. Interest and penalties on unrecognized tax benefits is reported by the Company as a component of tax expense, and the Company recorded interest and penalties in its consolidated statements of income in the amount of $0.1 million, $0.1 million, and $(0.5) million as of December 31, 2022, 2021, and 2020, respectively. As of December 31, 2022 and 2021, the accrued interest and penalties related to unrecognized tax benefits remained at $0.6 million.
F-45
There are no positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within 12 months of the reporting date.
Detailed below is a reconciliation of the Company's gross unrecognized tax benefits for the years ended December 31, 2022 and 2021, respectively (in thousands):
1,911
1,860
Changes related to current year tax positions
68
49
Changes related to prior year tax positions
Decreases due to lapsed statutes of limitations
1,940
Note 18 — Stock-Based Compensation
The Company’s Amended and Restated 2020 Omnibus Incentive Plan, or the 2020 Plan, authorizes grants of stock‑based compensation instruments to purchase or issue up to 2,770,000 shares of Company common stock.
In connection with its IPO in January 2020, the Company granted stock options to non-employee directors and certain employees, including named executive officers, to purchase approximately 782,500 shares of common stock with an exercise price per share equal to the initial public offering price of $13.00. On December 24, 2020, the Company granted stock options to a non-employee director to purchase 12,500 shares of common stock with an exercise price per share equal to the grant date market price of $6.28.
The Company uses the Black-Scholes option pricing model to value stock options in determining the stock-based compensation expense. Forfeitures are recognized as they occur. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the date of grant. The expected dividend yield was zero as the Company is not expected to pay dividends in the foreseeable future. Expected volatility is based on the estimated average maximum volatility provided by a third-party investment bank due to the lack of historical volatilities of the Company’s common stock.
There were no stock options granted in the years ended December 31, 2022, and 2021. The following table presents the assumptions used in the option pricing model at the grant date for options granted in the year ended December 31, 2020:
Assumptions:
Expected volatility
0.28
Expected dividends
Risk-free interest rate
1.50
Expected forfeited rate
The tables below summarize stock option activity during the years ended December 31, 2022 and 2021:
($ in thousands, except per share amounts)
Options
Weighted Average Exercise Price
Weighted Average Remaining Contractual Life
Aggregate Intrinsic Value
Options outstanding at beginning of year
785,000
12.89
Granted
Exercised
Forfeited
Options outstanding at end of year
7.1 years
Options exercisable at end of year
523,333
Options expected to vest (1)
261,667
F-46
8.1 years
93
62
The aggregate intrinsic value represents the amount by which the fair value of underlying stock exceeds the “in-the-money” option exercise price.
Stock options vest ratably over a service period of three years from the date of the grant. Compensation expense related to stock options is based on the fair value of the underlying stock on the award date and is recognized over the vesting period using the straight-line method. Unvested stock options outstanding were 261,667 and 523,333 shares as of December 31, 2022 and 2021, respectively, at a weighted average exercise price per share of $12.89. The amount of unrecognized compensation expense related to unvested stock options was $52.0 thousand, and the weighted average period over which it is expected to be recognized is 0.18 years as of December 31, 2022.
In January 2021, the Company issued 480,000 shares of restricted stock awards to certain employees, including named executive officers, at no cost to employees. In May 2021, the Company issued 26,511 shares of restricted stock awards to certain non-employee directors.
In February 2022, the Company issued 125,250 shares of restricted stock awards to certain employees, including named executive officers at no cost to employees. In May 2022, the Company issued 31,215 shares of restricted stock awards to certain non-employee directors.
The fair value of restricted stock awards is determined based on the fair market value of the Company's common shares on the grant date. The estimated fair value of restricted stock awards is amortized as an expense over the three-year requisite service period. The Company has elected to recognize forfeitures as they occurred rather than estimating service-based forfeitures over the requisite service period. The amount of unrecognized compensation expense related to unvested restricted stock awards was $2.7 million, and the weighted average period over which it is expected to be recognized is 1.63 years as of December 31, 2022.
The table below summarizes restricted stock award activity during the year ended December 31, 2022 and 2021:
Employee
Non-Employee Director
Restricted Stock Awards
Number of Shares
Weighted Average Grant Date Fair Value
Nonvested at December 31, 2021
480,000
7.04
26,511
10.75
7.23
125,250
12.63
31,215
9.13
11.93
Vested
(160,000
(8,837
(168,837
Nonvested at December 31, 2022
445,250
8.61
48,889
9.72
494,139
8.72
F-47
Nonvested at December 31, 2020
In February 2022, the Company granted 102,750 shares of performance stock unit ("PSU") to certain employees, including named executive officers under the 2020 Plan. PSUs will vest based on the achievement of predetermined performance goals over performance periods determined by the Compensation Committee. PSUs are subject to forfeiture until predetermined performance conditions have been achieved. The Company recognizes share-based compensation expense for PSUs on a straight-line basis over the requisite service period of the award when it is probable that the performance conditions will be achieved. Compensation expense for PSUs with financial performance measures is measured using the fair value at the date of grant and recorded over each vesting period, and may be adjusted over the vesting period based on interim estimates of performance against the pre-set objectives. The 102,750 PSUs granted in 2022 represent 100% of the original target award amount, vesting eligibility is based on performance and service conditions of three years. Accordingly, the number of shares issued at the end of the performance period could range between 0% and 200% of the original target award amount of 102,750 units.
A summary of the PSU activity as of December 31, 2022 under the 2020 Omnibus Plan is presented below:
Weighted Average Grant Date Fair Value (per share)
Outstanding at beginning of year, nonvested
102,750
Outstanding at end of year, nonvested
In July 2022, the Company initiated an ESPP which allows permitted eligible employees to purchase shares of the Company's common stock through payroll deductions of up to 15% of their eligible compensation, subject to certain limitations. The purchase price of the shares under the ESPP equals 85% of the lower of the fair market value of the Company's common stock on either the first or last day of each six-month offering period. As of December 31, 2022, 74,009 shares had been issued pursuant to ESPP.
Compensation expense for the ESPP is calculated as of the beginning of the offering period as the fair value of the employees’ purchase rights utilizing the Black-Scholes option valuation model and is recognized as a compensation expense over the offering period. The table below presents the fair value assumptions used for the period indicated:
2.50
Expected term (in years)
49.93
Dividend yield
Grant date fair value per share
11.31
F-48
The Company recognized a total of $3.1 million and $2.1 million compensation expense related to the outstanding stock options, unvested restricted stock awards, ESPP, and unvested performance-based stock unit awards granted to employees during the years ended December 31, 2022 and 2021, respectively. Such amount is included in “Compensation and employee benefits” on the Consolidated Statement of Income. The total amount of unrecognized compensation expense related to unvested stock options, restricted stock awards, and performance-based stock unit awards remained at $3.6 million as of December 31, 2022 and 2021.
Treasury share purchases represent shares surrendered to the Company equal in value to the statutory payroll tax withholding obligations arising from the vesting of employee restricted stock awards. During the three months ended March 31, 2022, the Company purchased treasury shares of 33,647 at an average price of $13.61 per share. No common stock purchases were made by the Company during the last nine months of 2022.
Note 19 — Earnings (Loss) Per Share
The two-class method is used in the calculation of basic and diluted earnings per share. Under the two-class method, earnings available to common shareholders for the period are allocated between common shareholders and participating securities according to dividends declared (or accumulated) and participation rights in undistributed earnings. Basic earnings per share is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if stock options or other contracts to issue common stock were exercised or converted into common stock and resulted in the issuance of common stock that shared in earnings.
The following table presents the basic and diluted income (loss) per share calculations for the years ended December 31, 2022, 2021, and 2020:
(In thousands, except per share data)
Basic EPS:
Less: deemed dividends on preferred stock
Net income (loss) attributable to common shareholders
Less: earnings attributable to participating securities
Net earnings (loss) attributable to common shareholders
Basic income (loss) per common share
Diluted EPS:
Add dilutive effects for assumed conversion of Series A preferred stock
8,989
Add dilutive effects for warrants
2,025
1,974
Add dilutive effects for stock options
Add dilutive effects of unvested restricted stock awards
188
203
Weighted average diluted common shares outstanding
Diluted income (loss) per common share
The following table sets forth the number of shares excluded from the computation of diluted earnings per share, as their inclusion would have been anti-dilutive (in-thousands):
Shares underlying Series A Convertible Preferred Stock
11,688
Shares underlying warrants
3,013
Stock options
773
785
Unvested restricted stock awards
Shares equivalents excluded from EPS
15,486
F-49
Note 20 — Convertible Redeemable Preferred Stock
On April 7, 2020, the Company issued and sold in a private placement Series A Convertible Preferred Stock plus warrants (the “Warrants”) to purchase additional shares of the Company’s common stock to funds affiliated with Snow Phipps and a fund affiliated with Pacific Investment Management Company LLC (TOBI). Snow Phipps and TOBI are considered affiliates and, therefore, are related parties to the Company. On October 8, 2021, the Company exercised its option to convert all of its 45,000 outstanding shares of Series A Convertible Preferred Stock into 11,688,310 shares of its common stock. "
The Warrants are exercisable at the warrantholder’s option at any time and from time to time, in whole or in part, until April 7, 2025 at an exercise price of $2.96 per share of common stock, with respect to 2,008,750 of the Warrants, and at an exercise price of $4.94 per share of common stock, with respect to 1,004,375 of the Warrants. The exercise price and the number of shares of common stock issuable upon exercise of the Warrants are subject to customary antidilution adjustments and certain issuances of common stock (or securities convertible into or exercisable for common stock) at a price (or having a conversion or exercise price) that is less than the then current exercise price. The Company is not required to affect an exercise of Warrants, if after giving effect to the issuance of common stock upon exercise of such Warrants such warrantholder together with its affiliates would beneficially own 49% or more of the Company’s outstanding common stock.
F-50
Note 21 — Concentration of Risk
The Company originates and purchases loans secured by a broad spectrum of commercial property throughout the United States. As of December 31, 2022 and 2021, geographic and property type concentrations of loans, by unpaid principal balance, were as follows:
Geographic concentration:
23.3
21.4
13.5
7.7
Other states (individually less than 5.0%)
34.1
Property type concentration:
50.7
12.8
9.1
6.1
6.7
Other (individually less than 5.0%)
5.8
As of December 31, 2022 and 2021, the Company held $13.3 million and $17.6 million, respectively, of real estate owned, net, with geographic concentrations as follows:
Maryland
16.8
Connecticut
Ohio
11.9
24.9
North Carolina
16.1
Massachusetts
21.3
Texas
14.1
13.4
23.9
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Note 22 — Commitments and Contingencies
When the Company sells loans, it is required to make normal and customary representations and warranties about the loans to the purchaser. The loan sale agreements generally require the Company to repurchase loans if the Company breaches a representation or warranty given to the loan purchaser. In addition, the Company may be required to repurchase loans as a result of borrower fraud or if a payment default occurs on a loan shortly after its sale.
The Company records a repurchase liability relating to representations and warranties and early payment defaults. The method used to estimate the liability for repurchase is a function of the representations and warranties given and considers a combination of factors, including, but not limited to, estimated future defaults and loan repurchase rates and the potential severity of loss in the event of defaults. The Company establishes a liability at the time loans are sold and continually update the estimated repurchase liability. The level of the repurchase liability for representations and warranties and early payment default requires considerable management judgment.
The Company regularly evaluates the adequacy of repurchase reserves based on trends in repurchase, actual loss experience, estimated future loss exposure and other relevant factors including economic conditions. As of December 31, 2022 and 2021, the balance of repurchase liability was $124 thousand and $141 thousand, respectively, and it is included in accounts payable and accrued expenses in the consolidated balance sheets.
The Company is a party to various legal proceedings in the normal course of business. The Company, after consultation with legal counsel, believes the disposition of all pending litigation will not have a material effect on the Company’s consolidated financial condition or results of operations.
Note 23— Retirement Plan
The Company maintains a qualified 401(k) retirement plan in accordance with the Internal Revenue Service code. Employees meeting certain eligibility requirements as detailed in the plan document may participate by deferring eligible compensation into the plan. The plan allows for discretionary employer matching contribution. For the years ended December 31, 2022, 2021, and 2020, the Company expensed $794 thousand, $579 thousand, and $476 thousand, respectively. These amounts are included in "compensation and employee benefits" on the consolidated statements of income.
Note 24 — Other Operating Expenses
The following table presents the components of other operating expenses for the years ended December 31, 2022, 2021 and 2020 (in thousands):
Travel, marketing and business development
1,421
661
Data processing and telecommunications
3,022
2,476
2,150
Office expenses
1,161
1,396
Insurance, taxes, and licenses
2,452
2,457
2,179
1,498
1,914
Total other operating expenses
F-52
Note 25 — Related Party Transactions
On April 7, 2020, the Company issued and sold in a private placement 45,000 newly issued shares of Series A Convertible Preferred Stock, par value $0.01 per share (the “Preferred”), at a price per share of $1,000, plus warrants (the “Warrants”) to purchase an aggregate of 3,013,125 shares of the Company’s common stock to funds affiliated with Snow Phipps and a fund affiliated with Pacific Investment Management Company LLC (TOBI). Snow Phipps and TOBI are considered affiliates and, therefore, are related parties to the Company. On October 8, 2021, the Company exercised its option to convert all of its 45,000 outstanding shares of Series A Convertible Preferred Stock into 11,688,310 shares of its common stock.
In the ordinary course of business, the Company sells held for sale loans to various financial institutions through a market bidding process. As a result of this process, the Company may sell held for sale loans to an affiliate. The Company sold $188.4 million and $0.1 million in UPB of loans to an affiliate during the years ended December 31, 2022 and 2021, respectively.
Note 26 — Fair Value Measurements
ASC Topic 820, “Fair Value Measurement,” defines fair value, establishes a framework for measuring fair value including a three-level valuation hierarchy, and requires disclosures about fair value measurements. Fair value is defined as the exchange price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date reflecting assumptions that a market participant would use when pricing an asset or liability. The hierarchy uses three levels of inputs to measure the fair value of assets and liabilities as follows:
Given the nature of some of the Company’s assets and liabilities, clearly determinable market-based valuation inputs are often not available; therefore, these assets and liabilities are valued using internal estimates. As subjectivity exists with respect to the valuation estimates used, the fair values disclosed may not equal prices that can ultimately be realized if the assets are sold or the liabilities are settled with third parties.
Below is a description of the valuation methods for the assets and liabilities recorded at fair value on either a recurring or nonrecurring basis and for estimating fair value of financial instruments not recorded at fair value for disclosure purposes. While management believes the valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the measurement date.
Cash and restricted cash are recorded at historical cost. The carrying amount is a reasonable estimate of fair value as these instruments have short-term maturities and interest rates that approximate market, a Level 1 measurement.
Loans held for investment originated prior to October 1, 2022, are recorded at amortized cost, which is their outstanding principal balance, net of purchase discounts, deferred loan origination fees/costs, and allowance for credit losses. Effective October 1, 2022, the Company elected to carry its newly originated loans at fair value using FASB ASC Topic 825, Financial Instruments (ASC 825).
F-53
The Company determines the fair value estimate of loans held for investment using a third-party loan valuation model, a Level 3 measurement. The significant unobservable inputs used in the fair value measurement of the Company’s mortgage loans held for investment are discount rates, prepayment speeds, loss severity, and default rates. Significant changes in any of those inputs could result in a significant change to the loans’ fair value measurement.
Nonaccrual loans held for investment at amortized cost are evaluated individually and are recorded at fair value on a nonrecurring basis. To the extent such a loan is collateral dependent, the Company determines the allowance for credit losses based on the estimated fair value of the underlying collateral. The fair value of each loan’s collateral is generally based on appraisals or broker price opinions obtained, less estimated costs to sell, a Level 3 measurement.
Loans held for sale that were originated prior to October 1, 2022, are carried at the lower of cost or fair value, with fair value adjustments recorded on a nonrecurring basis. The Company uses a discounted cash flow model to estimate the fair value of loans held for sale, a Level 3 measurement.
Loans held for sale that are originated effective October 1, 2022, are carried at fair value. The Company determines the fair value estimate of loans held for sale using a third-party loan valuation model, a Level 3 measurement. The significant unobservable inputs used in the fair value measurement of the Company’s mortgage loans held for investment are discount rates, prepayment speeds, loss severity, and default rates. Significant changes in any of those inputs could result in a significant change to the loans’ fair value measurement.
The Company has also elected to account for certain loans originated with the intent to sell to Ginnie Mae at fair value. These loans are measured based on the fair value of securities backed by similar mortgage loans, adjusted for certain factors to approximate the fair value, including the value attributable to mortgage servicing and credit risk, and current commitments to purchase loans, a Level 2 measurement.
Management identified all of these loans to be accounted for at estimated fair value at the instrument level. Changes in fair value are reflected in income as they occur.
The Company retains an interest-only strip on certain sales of held for sale loans. The interest-only strips are classified as trading securities under FASB ASC Topic 320, Investments-Debt Securities. The interest-only strips are measured based on their estimated fair values using a discounted cash flow model, a Level 3 measurement. Changes in fair value are reflected in income as they occur.
The Company has elected to account for certain purchased distressed loans held for investment, at fair value (the FVO Loans) using FASB ASC Topic 825, Financial Instruments (ASC 825). The FVO loans are measured based on their estimated fair values. Management identified all of these loans to be accounted for at estimated fair value at the instrument level. Changes in fair value are reflected in income as they occur.
The Company uses a modified discounted cash flow model to estimate the fair value at instrument level, a Level 3 measurement. The significant unobservable inputs used in the fair value measurement of the Company’s mortgage loans held for investment, at fair value are discount rate, property values, prepayment speeds, loss severity, and default rates. Significant changes in any of those inputs in isolation could result in a significant change to the loans’ fair value measurement.
F-54
Real estate owned, net is initially recorded at the property’s estimated fair value, based on appraisals or broker price opinions obtained, less estimated costs to sell, at the acquisition date, a Level 3 measurement. From time to time, nonrecurring fair value adjustments are made to real estate owned, net based on the current updated appraised value of the property, or management’s judgment and estimation of value based on recent market trends or negotiated sales prices with potential buyers.
The Company determined the fair values based on a third-party valuation model that calculates the present value of estimated future net servicing income, a Level 3 measurement.
The Company determined the fair values estimate of the secured financing using the estimated cash flows discounted at an appropriate market rate, a Level 3 measurement.
Warehouse repurchase facilities are recorded at historical cost. The carrying amount is a reasonable estimate of fair value as these instruments have short-term maturities of one-year or less and interest rates that approximate market plus a spread, a Level 2 measurement.
The fair value estimate of securities issued is determined by using estimated cash flows discounted at an appropriate market rate, a Level 3 measurement.
The carrying amounts of accrued interest receivable and accrued interest payable approximate fair value due to the short-term nature of these instruments, a Level 1 measurement.
The Company does not have any off-balance sheet financial instruments.
The carrying amounts of receivables due from servicers approximate fair value due to the short-term nature of these instruments, a Level 1 measurement.
The following tables present information on assets measured and recorded at fair value as of December 31, 2022 and 2021, by level, in the fair value hierarchy (in thousands):
Fair value measurements using
Total at
Level 1
Level 2
Level 3
Recurring fair value measurements:
Total recurring fair value measurements
285,333
Nonrecurring fair value measurements:
Individually evaluated loans requiring specific allowance, net
Total nonrecurring fair value measurements
24,791
310,124
F-55
8,511
11,987
116,966
125,477
The following table presents gain (losses) recognized on assets measured on a nonrecurring basis for the years indicated (in thousands):
Gain (loss) on assets measured on a nonrecurring basis
328
Real estate held for sale, net
310
1,262
(1,755
Total net loss
(53
(480
(3,161
The following tables present the primary valuation techniques and unobservable inputs related to Level 3 assets as of December 31, 2022 and 2021 ($ in thousands):
Asset category
Fair value
Primaryvaluationtechnique
Unobservableinput
Range
Weightedaverage
Individually evaluated loans requiring allowance, net
$11,466
Market comparables
Selling costs
8.0%
Discounted cash flow
Discount rate
8.35% to 9.35%
8.9%
Collateral value (% of UPB)
88.47% to 103.5%
99.1%
Timing of resolution/payoff (months)
1 to 49
36.9
Prepayment rate
1.0% to 30.0%
15.1%
Default rate
0.12% to 6.99%
0.6%
Loss severity rate
0.0% to 18.45%
3.5%
8.0% to 12.0%
8.1%
5.6% to 16.8%
6.3%
F-56
$11,987
5.8%
95.0% to 120.0%
106.0%
1 to 38
34.8
19.2% to 50%
19.5%
0.0% to 6.7%
1.0%
0.0% to 13.4%
3.0%
87,442
3 to 37
13.0
2.4% to 3.5%
3.2%
The following is a rollforward of loans that are measured at estimated fair value on a recurring basis for the years indicated (in thousands):
Originations
267,278
Repurchase
1,048
Loans liquidated
(765
(163
(1,808
Principal paydowns
(261
(46
(55
Total unrealized gain (loss) included in net income
7,436
The following is a rollforward of interest-only strips that are measured at estimated fair value on a recurring basis for the years indicated (in thousands):
238
894
Interest-only strip additions
1,820
Interest-only strip write-offs
(238
(2,469
Total unrealized loss included in net income
F-57
The Company estimates the fair value of certain financial instruments on a quarterly basis. These instruments are recorded at fair value using a valuation allowance only if they are impaired. As described above, these adjustments to fair value usually result from the application of lower of cost or fair value accounting or write-downs of individual assets. As of December 31, 2022 and 2021, the only financial assets measured at fair value were certain impaired loans held for investment, loans held for sale, interest-only strips, REO and FVO loans, which were measured using unobservable inputs, including appraisals and broker price opinions on the values of the underlying collateral. Impaired loans were carried at approximately $11.5 million and $12.0 million as of December 31, 2022 and 2021, net of specific allowance for loan losses of approximately $1.1 million and $1.4 million, respectively.
A financial instrument is cash, evidence of an ownership interest in an entity, or a contract that creates a contractual obligation or right to deliver or receive cash or another financial instrument from a second entity on potentially favorable terms. The methods and assumptions used in estimating the fair values of the Company’s financial instruments are described above.
The following tables present carrying amounts and estimated fair values of certain financial instruments as of the dates indicated (in thousands):
Carrying
Estimated
Value
Fair Value
Assets:
Cash
3,201,850
Liabilities:
211,854
2,522,010
Accrued interest payable
16,369
2,655,357
Accrued interest receivable
170,843
1,931,002
6,254
F-58
Note 27 — Select Quarterly Financial Data (Unaudited)
The following tables set forth the Company's unaudited quarterly results for the periods indicated:
8,227
10,290
10,771
3,231
Note 28 — Subsequent Events
The Company completed the securitization of $240.3 million of investor real estate loans on January 10, 2023 which will be accounted for as secured borrowings during the quarter ending March 31, 2023.
The Company has evaluated events that have occurred subsequent to December 31, 2022 and has concluded there are no other subsequent events that would require recognition in the accompanying consolidated financial statements.
F-59
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
VELOCITY FINANCIAL, INC.
Date: March 09, 2023
By:
/s/ Christopher D. Farrar
Name:
Christopher D. Farrar
Title:
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
Title
Date
Chief Executive Officer and Director
March 09, 2023
(Principal Executive Officer)
/s/ Mark R. Szczepaniak
Chief Financial Officer
Mark R. Szczepaniak
(Principal Financial Officer)
/s/ Fiona L. Tam
Chief Accounting Officer
Fiona L. Tam
(Principal Accounting Officer)
/s/ Alan H. Mantel
Chair of the Board of Directors
Alan H. Mantel
/s/ Michael W. Chiao
Director
Michael W. Chiao
/s/ John P. Pitstick
John P. Pitstick
/s/ John A. Pless
John A. Pless
/s/ Joy L. Schaefer
Joy L. Schaefer
/s/ Dorika M. Beckett
Dorika M. Beckett
/s/ Katherine L. Verner
Katherine L. Verner