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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, 2023
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, 2023, the aggregate market value of voting and non-voting common stock held by non-affiliates of the registrant was $100.7 million, based on a closing price of $11.53.
As of March 1, 2024, the registrant had 32,965,081 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 2024 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 41.
Table of Contents
Page
PART I
1
Item 1.
Business
Item 1A.
Risk Factors
8
Item 1B.
Unresolved Staff Comments
Item 1C
Cybersecurity
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.
[Reserved]
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
10
Item 8.
Financial Statements and Supplementary Data
37
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
38
Item 9A.
Controls and Procedures
Item 9B.
Other Information
39
PART III
40
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
41
Item 15.
Exhibits, Financial Statement Schedules
Item 16.
Form 10-K Summary
42
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:
i
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.
ii
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.
iii
Item 1. Business.
Our Company
We are a vertically integrated real estate finance company founded in 2004. We originate, securitize, and manage a nationwide portfolio of loans secured by real estate to earn attractive risk adjusted spreads for our shareholders. We primarily originate investor loans secured by 1-4 unit residential rental properties, as well as loans for multi-family, mixed use and commercial properties. We originate loans nationwide across our extensive network of independent mortgage brokers and direct borrower relationships, which we have built and refined over the 19 years since our inception. Our objective is to be the preferred and one of the most recognized brands in our core market.
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, from 1965 through 2023, 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 September 2023, the value of the U.S. residential housing sector is over $52 trillion. Ownership of residential properties for rent has historically been concentrated among smaller investors. According to data published by the Urban Institute in April and September 2023, an estimated 95% of investors own properties with one to four units and an estimated 98% of investors own 10 or fewer units, while institutional ownership comprises less than 4% 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 19-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 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.”
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. 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, 2023.
Market Uncertainties
Our operational and financial performance will depend on certain market developments, including any lingering impact of the COVID-19 pandemic, or other highly contagious or infectious disease, the Russia/Ukraine war, the Gaza-Israel conflict, a global recession, heightened stress in residential or commercial real estate, securitization markets, corporate debt markets, and macroeconomic conditions and market fundamentals, which can all 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 thirty-one securitizations of our investor real estate loans, issuing $6.4 billion in principal amount of securities between 2011 and the year ended December 31, 2023. We have a keen understanding of this securitization market, including complicated structural issues, investor expectations and rating agency requirements. We executed our twenty-sixth through thirty-first securitizations in 2023. 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 19 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 $124.3 million in portfolio related net interest income for the year ended December 31, 2023, representing a 3.34% net interest margin during the year.
2
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.
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 3,086 mortgage brokers with whom we have done business over the last five years. Approximately 88% of loan originators originated five or fewer loans with us during the year ended December 31, 2023. 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 2,930 loans sourced by 1,046 different mortgage brokers during the year ended December 31, 2023. We believe that represents a small portion of the mortgage originators in the United States, which consisted of approximately 885,933 state-licensed mortgage originators as of June 30, 2023, 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.
3
Develop New Products
Our primary product is a 30-year fixed-rate amortizing term loan. These loans comprised 90.0% of our loan originations during the year ended December 31, 2023. This product is used by borrowers to finance stabilized long-term real estate investments. We believe this product has 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 54.9% of our held for investment loan portfolio as of December 31, 2023.
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. In 2023, we issued our first securitization of these newly originated, short-term 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. 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, 2023, has an average balance of approximately $389,000. As of December 31, 2023, our portfolio of loans held for investment totaled $4.1 billion of unpaid principal balance, or UPB, on properties in 45 states and the District of Columbia. Of the 10,424 loans held for investment as of December 31, 2023, 99.1% of the portfolio, as measured by UPB, was attributable to our loan origination business, while the remaining 0.9% of the portfolio, or 56 loans, totaling $35.2 million in UPB, was related to acquisitions. During the years ended December 31, 2023 and 2022, we originated 2,955 and 4,135 loans to be held for investment totaling $1.1 billion and $1.7 billion, respectively.
As of December 31, 2023, 86.1% 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, 2023, our loans held for investment had a weighted average LTV at origination of 67.7%. Additionally, as of December 31, 2023, borrowers personally guaranteed 100.0% of the loans in our held for investment portfolio and had a weighted average credit score at origination of 718, excluding the 1.4% 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, 2023:
(*) 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 $300 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 2022 MC1 and 2023-RTL1 transactions which were issued as 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, 2023, we had successfully executed thirty-one securitizations of our investor real estate loans, issuing $6.4 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 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. In August 2023, we completed our first securitization collateralized by our short-term loan product with $81.6 million in securities issued.
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.
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.
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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, 2023, we had a total of 253 employees, an increase of 30% from the prior year. None of our employees are represented by a labor union. The increase in our employees was a result of growing the business.
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 27% 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, 68% of our employees are men and 32% 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, 2023, substantially all our employees have been able, and continue, to work remotely.
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 corporate office is located at 30699 Russell Ranch Road, Suite 295, Westlake Village, California 91362, and the telephone number of our office 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.
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Item 1A. Risk Factors.
Intentionally omitted pursuant to smaller reporting company reduced disclosure requirements.
Item 1B. Unresolved Staff Comments.
None.
Item 1C. Cybersecurity.
Cybersecurity Risk Management and Strategy
The Company has processes in place for assessing, identifying and managing material risks from cybersecurity threats. Our processes include, but are not limited to, the following:
Our Chief Information Officer (the "CIO") is primarily responsible for this cybersecurity component, reporting directly to the Chief Executive Officer, who periodically reports to our Board of Directors. To date, risks from cybersecurity threats or incidents have not materially affected our company. However, the sophistication of and risks from cybersecurity threats and incidents continue to increase, and the preventative actions that we have taken and continue to take to reduce the risk of cybersecurity threats and incidents and protect our systems and information may not successfully protect against all cybersecurity threats and incidents.
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, 2024, there were approximately 1,560 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
There were no unregistered equity securities sales nor were there any repurchases of common stock, which have not been previously disclosed in a quarterly report on Form 10-Q or a current report on Form 8-K during the period covered by this report.
Item 6. [Reserved]
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 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, 2023, has an average balance of approximately $389,000. As of December 31, 2023, our loan portfolio totaled $4.1 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 67.8%, and was concentrated in 1-4 unit residential rental loans, which we refer to as investor 1-4 loans, representing 55.0% of the UPB. During the year ended December 31, 2023, the yield on our total portfolio was 8.34%.
We fund our portfolio primarily through a combination of committed and uncommitted secured warehouse facilities, securitized debt, corporate debt and equity. The securitized debt market is our primary source of long-term, non-recourse financing. We have successfully executed 31 securitized debt offerings, issuing $6.4 billion in principal amount of securities from May 2011 through December 2023.
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 securitized debt and excludes our corporate debt. For the year ended December 31, 2023, our portfolio related net interest margin was 3.34%. 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, 2023, we generated pre-tax and net income of $71.1 million and $52.3 million, respectively, and earned a pre-tax return on equity and return on equity of 17.5% and 12.8%, 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.
Fair Value Option Accounting
We 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.
The FVO accounting for our securitized debt is on a case-by-case basis effective January 1, 2023. The fair value option securitized debt is presented on a separate line item in the consolidated balance sheet.
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
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 $175.0 million syndicated corporate debt ("2021 Term Loan"). We incurred $29.5 million and $16.6 million of interest expense related to our corporate debt during the years ended December 31, 2022 and 2023, respectively. $29.5 million of interest expense in 2022 included a one-time debt issuance cost write-off of $7.7 million and prepayment penalties of $5.3 million.
Recent Developments
Securitized Debt
In January 2024, we completed the securitization of $221.1 million of investor real estate loans, as measured by UPB.
In February 2024, the Company issued $75 million principal amount of five-year Senior Secured Notes. The Notes bear interest at 9.875% and mature on February 15, 2029.
During the year ended December 31, 2023, the Company began utilizing forward starting interest rate derivative instruments designated as cash flow hedges to manage the exposure to interest rate volatility associated with future issuances of fixed-rate debt. The gains or losses on forward starting interest rate derivative instruments that are designated and qualify as cash flow hedges are reported as a component of accumulated other comprehensive income.
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, the Israel-Gaza Conflict, a global recession, heightened stress in the real estate and corporate debt markets, recent bank failures, 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.
11
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.
12
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 2012-2023 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, U.S. real gross domestic product (GDP), treasury yields, 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 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.
In accordance with ASC 820, we utilize a third-party loan valuation model to estimate the fair value of our nonperforming mortgage loans. We use an in-house loan valuation model to estimate the fair value of our performing mortgage loans. 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.
13
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 securitized debt. 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.
14
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.
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 and Israel/Hamas wars, 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 $11.7 million or 10.4% from $112.6 million for the year ended December 31, 2022 to $124.3 million for the year ended December 31, 2023. 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 securitized debt, corporate debt, and equity. We believe we have an established brand in the term securitized debt 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 securitized debt 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 securitized debt.
One of our seven warehouse repurchase and revolving loan facilities has interest payment obligations tied to the one-month American Interbank Offered Rate, ("AMERIBOR"). Six of our warehouse repurchase and revolving loan facilities have interest payment obligations tied to the Secured Overnight Offering Rate ("SOFR").
15
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 for long term loans, 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
December 31,
2023
2022
2021
($ in thousands)
Total loans (UPB)
$
4,072,890
3,512,486
2,587,221
Loan count
10,477
8,893
6,964
Average loan balance
389
395
372
Weighted average loan-to-value
67.8
%
68.2
67.7
Weighted average coupon
8.88
7.95
7.76
Nonperforming loans (UPB) (A)
394,562
292,789
273,100
Nonperforming loans (% of total) (A)
9.69
8.34
17.11
(A) Reflects the UPB of loans 90 days or more past due or placed on nonaccrual status. Includes $42.2 million, $39.6 million, and $53.8 million of COVID-19 forbearance-granted loans 90 days or more past due as of December 31, 2023, 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.
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.
16
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, 2023:
Loan originations — held for investment
2,955
1,079,811
365
11.1
66.4
Loan originations — held for sale
38,036
3,804
7.9
48.2
Total loans originated
2,965
1,117,847
Year Ended December 31, 2022:
4,133
1,730,526
419
69.2
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
For the year ended December 31, 2023, we originated $1.1 billion of loans, which was a decrease of $644.0 million, or 36.6% from $1.8 billion for the year ended December 31, 2022. The 2022 originations increased by $435.6 million, or 32.8% from $1.3 billion for the year ended December 31, 2021.
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:
(in thousands)
Unpaid principal balance
4,055,936
2,499,798
Valuation adjustments on FVO loans
54,677
7,463
27
Deferred loan origination costs
28,351
33,429
33,360
Total loans held for investment, gross
4,138,964
3,553,378
2,533,185
Allowance for credit losses
(4,769
)
(4,893
(4,262
Loans held for investment, net
4,134,195
3,548,485
2,528,923
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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 the dates indicated:
UPB
Loans due in less than one year
151,670
3.8
146,916
4.2
96,502
3.9
Loans due in one to five years
54,345
1.3
31,777
0.9
5,023
0.2
Loans due in more than five years
3,849,921
94.9
3,333,793
2,398,273
96.0
Total loans held for investment
100.0
Our allowance for loan losses decreased to $4.8 million as of December 31, 2023, from $4.9 million as of December 31, 2022. The decrease in allowance is primarily due to loan paydowns and payoffs decreasing our portfolio of loans held for investment carried at amortized cost.
Our allowance increased to $4.9 million as of December 31, 2022, from $4.3 million as of December 31, 2021. The increase in allowance was 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 $3.2 billion as of December 31, 2022.
Our allowance for loan losses is based on an analysis of historical loan loss data from January 1, 2017 through December 31, 2023, 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 portfolio of loans held for investment carried at amortized cost, 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.
The following table illustrates the activity in our allowance for loan losses over the periods indicated:
Allowance for credit losses:
Beginning balance
4,893
4,262
5,845
Provision for (reversal of) loan losses
1,915
1,152
(292
Charge-offs
(2,039
(521
(1,291
Ending balance
4,769
Total loans held for investment (UPB), excluding FVO (1)
2,804,541
3,243,854
2,498,466
Allowance for credit losses / loans held for investment, excluding FVO
0.17
0.15
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Credit Quality – Loans Held for Investment and Loans Held for Investment at Fair Value
The following table provides delinquency information on our loans held for investment and loans held for investment at fair value by UPB as of the dates indicated:
December 31, 2023 (A)
COVID-19Forbearance
December 31, 2022 (A)
December 31, 2021 (A)
Performing/Accruing:
Current
3,354,197
82.7
116,060
2,969,989
84.6
120,884
2,068,023
188,466
30-59 days past due
231,590
5.7
11,993
186,051
5.3
33,668
127,046
5.1
36,579
60-89 days past due
75,587
1.9
4,336
63,657
1.8
6,902
31,629
8,262
90+ days past due
Total performing loans
3,661,374
90.3
132,389
3,219,697
91.7
161,454
2,226,698
89.1
233,307
Nonperforming/Nonaccrual:
<90 days past due
17,746
0.4
1,562
17,852
0.5
1,116
19,533
0.8
5,325
24,398
0.6
32,566
1,681
35,787
1.4
8,510
Bankruptcy
35,993
3,705
22,435
7,272
20,038
6,242
In foreclosure
316,425
7.8
36,915
219,936
6.3
29,482
197,742
39,045
Total nonperforming loans
9.7
42,182
8.3
39,551
10.9
59,122
174,571
201,005
292,429
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 $394.6 million, or 9.7% of our held for investment loan portfolio as of December 31, 2023, compared to $292.8 million, or 8.3% as of December 31, 2022, and $273.1 million, or 10.9% of the loan portfolio as of December 31, 2021. The increase in total nonperforming loans as of December 31, 2023 compared to December 31, 2022 is due to an increase in the size of our portfolio and management’s decision to move loans into foreclosure early in the delinquency process. The increase in total nonperforming loans as of December 31, 2022 compared to December 31, 2021 was primarily attributable to a larger loan portfolio offset by loan resolutions from our Special Servicing department.
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 $206.1 million, $142.2 million, and $201.9 million of long-term and short-term nonperforming loans during the years ended December 31, 2023, 2022, and 2021, respectively. We also resolved $19.3 million, $16.2 million, and $10.7 million of long-term and short-term nonperforming loans transferred to REO during the years ended December 31, 2023, 2022 and 2021, respectively. From these resolution activities, we realized net gains of $5.5 million, $10.8 million, and $7.5 million during the years ended December 31, 2023, 2022, and 2021, 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 REOs.
Long-Term Loans
December 31, 2023
December 31, 2022
December 31, 2021
Gain /(Loss)
Resolved — paid in full
67,769
3,181
50,441
5,073
62,703
4,106
Resolved — paid current
101,224
925
46,062
449
45,654
650
Resolved — REO sold
13,335
57
10,204
1,602
10,151
226
Total resolutions
182,328
4,163
106,707
7,124
118,508
4,982
Recovery rate on resolved nonperforming UPB
102.3
106.7
104.2
19
The table below includes resolutions for our short-term nonperforming loans and REOs, and also includes loans that were granted a COVID-19 forbearance in 2020. The short-term loans, or loans with a maturity of two-year or less, 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
18,301
741
36,516
2,100
43,613
2,312
18,775
111
9,192
61
49,942
195
5,919
506
5,966
1,474
534
22
42,995
1,358
51,674
3,635
94,089
2,529
103.2
107.0
102.7
Our recovery rates were elevated in 2022 because of the positive resolution of loans impacted by the COVID pandemic.
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, included in "real estate owned, net" in the consolidated statements of income.
As of December 31, 2023, our REO included 71 properties with a carrying value of $44.3 million compared to 27 properties with a carrying value of $13.3 million as of December 31, 2022.
Charge-offs, Gain/(Loss) on REO
Our actual charge-offs have been minimal as a percentage of nonperforming loans held for investment. The valuation impact to our P&L from loans becoming REO or in REO is a combination of 1) loan charge-offs, 2) gain on transfer to REO included in "gain on disposition of loans" in the consolidated statements of income, 3) net gain/(loss) on sale of REO, and 4) net valuation adjustments on REO. The table below shows our actual charge-offs; gain on transfer of nonperforming loans to REO; gain on disposition of REO; and net valuation adjustments on REO; for the periods indicated.
Year Ended December 31,
Average nonperforming loans for the period (1)
328,105
266,129
307,562
Charge-offs / Average nonperforming loans for the period (1)
0.62
0.20
0.42
Gain on transfer to REO
7,412
3,408
1,117
Gain on sale of REO
568
2,939
409
REO valuations, net
(3,903
(364
(1,759
Total gain/(loss) on REO
2,038
5,462
(1,524
20
Concentrations – Loans Held for Investment
As of December 31, 2023, our held for investment loan portfolio was concentrated in investor 1-4 loans, representing 54.9% of the UPB and mixed-use properties represented 11.7% 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 21.9% in California, 18.3% in New York, 13.4% in Florida, and 7.3% in New Jersey.
Property Type
% of Total UPB
Investor 1-4
6,478
2,224,795
54.9
Mixed use
1,147
474,913
11.7
Retail
715
343,992
8.5
Multifamily
578
316,326
Warehouse
394
265,032
6.5
Office
513
221,270
5.5
Other (1)
599
209,608
10,424
Geography (State)
California
1,345
889,681
21.9
New York
1,352
744,091
18.3
Florida
1,385
543,546
13.4
New Jersey
901
295,038
7.3
5,441
1,583,580
39.1
Key Performance Metrics
Average loans
3,725,197
3,092,198
2,125,847
Portfolio yield
7.77
8.56
Average debt — portfolio related
3,341,411
2,750,822
1,814,048
Average debt — total company
3,556,411
2,956,801
1,968,938
Cost of funds — portfolio related
5.58
4.64
4.71
Cost of funds — total company
5.71
5.32
5.38
Net interest margin — portfolio related
3.34
3.64
4.54
Net interest margin — total company
2.89
2.69
3.57
Charge-offs/Average loans held for investment, excluding FVO loans
0.07
0.02
0.06
Pre-tax return on equity
17.46
12.23
15.58
Return on equity
12.84
8.93
11.45
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,
21
cash interest received on nonperforming loans, default interest and prepayment fees. Portfolio yield was higher in 2023 primarily due to higher interest rates for new originations in 2023 as compared to 2022.
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 securitized debt. 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 securitized debt, we have been able to fix a significant portion of our borrowing costs over time. The strong credit performance on our securitized debt has allowed us to issue debt at attractive rates. Our portfolio related cost of funds increased to 5.58% for the year ended December 31, 2023 from 4.64% and 4.71% for the years ended December 31, 2022 and 2021, 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.
Over the periods shown below, our portfolio related net interest margin decreased to 3.34% for the year ended December 31, 2023 compared to the 3.64% for the year ended December 31, 2022, and decreased from 4.54% for the year ended December 31, 2021. The decreases were primarily due to higher debt cost caused by an overall increase in interest rates.
Our total company net interest margin of 2.89% for the year ended December 31, 2023 increased from 2.69% for the year ended December 31, 2022, and decreased from 3.57% for the year ended December 31, 2021. The increase in total company net interest margin from the year ended December 31, 2022 was due to the lower interest expense on our corporate debt. The decrease in total company net interest margin from the year ended December 31, 2021 was primarily due to higher interest rates.
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
8,615
49,194
15,794
Loans held for investment
3,716,582
3,043,003
2,110,053
Total loans
310,775
240,343
181,968
Debt:
Warehouse and repurchase facilities
227,911
21,726
9.53
292,490
17,454
5.97
183,663
9,706
5.28
Securitized debt
3,113,500
164,742
5.29
2,458,332
110,269
4.49
1,630,385
75,680
Total debt - portfolio related
186,468
127,723
85,386
Corporate debt
215,000
16,556
7.70
205,979
29,472
14.31
154,890
20,609
13.31
Total debt
203,024
157,195
105,995
Net interest spread - portfolio related (1)
2.76
3.13
3.85
Net interest margin - portfolio related
Net interest spread - total company (2)
2.63
2.46
3.18
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.
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. Pre-tax return on equity and return on equity increased for the year ended December 31, 2023 as compared to 2022 and 2021 due to the increase in income before income taxes and net income as further explained below.
Income before income taxes (A)
71,127
44,552
39,793
Net income (B)
52,293
32,519
29,224
Monthly average balance:
Stockholders' / Members' equity (C)
407,305
364,282
255,331
Pre-tax return on equity (A)/(C)
17.5
12.2
15.6
Return on equity (B)/(C)
12.8
8.9
11.4
23
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 carried at the lower of cost or fair value, are deferred as part of the carrying value of the loan and recognized as a gain or loss on the sale of the loan. The fees and costs associated with loans held for sale carried at fair value are recognized and expensed as incurred
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 securitized debt. 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 securitized debt 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. We do not record provision for loan losses on loans held for sale, or loans carried at fair value.
24
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, less estimated costs to sell, 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 a loan charge-off.
Unrealized Gain/(Loss) on Fair Value Loans. We have elected to apply the fair value option accounting to all our originated mortgage loans on a go-forward basis beginning October 1, 2022. We have 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. Changes in fair value subsequent to initial recognition of fair value loans are reported as unrealized gain/(loss) on fair value loans, a component of other operating income within the consolidated statements of income.
Unrealized Gain/(Loss) on Mortgage Servicing Rights. The Company has elected to record its mortgage servicing rights using the fair value measurement method. Changes in fair value are reported as unrealized gains/(losses) on mortgage servicing rights.
Unrealized Gain/(Loss) on Fair Value Securitized Debt. We have elected to apply the fair value option accounting to securitized debt issued effective January 1, 2023 when the underlying collateral is also carried at fair value. We regularly estimate the fair value of securitized debt. Changes in fair value subsequent to initial recognition of fair value securitized debt are reported as unrealized gain/(loss) on fair value securitized debt, a component of other operating income within the consolidated statements of income.
Origination Fee Income. Fee income related to our loan origination activities.
Interest Income on cash balance. Interest income on bank balances.
Other Income. Other income primarily consists of servicing fee income and other miscellaneous income. Century earns servicing fees for servicing mortgage loans for others.
Compensation and Employee Benefits. Costs related to employee compensation, commissions and related employee benefits, such as health, retirement, and payroll taxes.
Origination Expenses. Costs related to our loan origination activities.
Securitization Expenses. Costs related to issuance of our securitized debt.
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.
Rent and Occupancy. Costs related to occupying our locations, including rent, maintenance and property taxes.
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.
25
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 net income with various permanent differences. The tax-adjusted net 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 income
Interest expense - portfolio related
Net interest income - portfolio related
124,307
112,620
96,582
Interest expense - corporate debt
Net interest income
107,751
83,148
75,973
Net interest income after provision for loan losses
105,836
81,996
76,265
Other operating income
65,910
24,321
9,798
Total operating expenses
100,619
61,765
46,269
Income before income taxes
39,794
Income tax expense
18,834
12,033
10,569
Net income
29,225
Net income attributable to noncontrolling interest
308
Net income attributable to Velocity Financial, Inc.
52,273
32,211
Less undistributed earnings attributable to participating securities
753
491
8,589
Less deemed dividends on preferred stock
Net income allocated to common shareholders
51,520
31,720
20,636
Earnings per common share
Basic
1.60
0.99
0.90
Diluted
1.52
0.94
0.86
Weighted average common shares outstanding
32,206
31,913
22,813
34,484
34,131
33,982
Year Ended December 31, 2023 Compared to Year Ended December 31, 2022
$ Change
% Change
70,432
29.3
58,745
46.0
11,687
10.4
Portfolio related net interest income is the largest contributor to our net income. Our portfolio related net interest income increased to $124.3 million from $112.6 million for the year ended December 31, 2023 and 2022.
Interest Income. Interest income increased by $70.4 million, or 29.3%, to $310.8 million for the year ended December 31, 2023, compared to $240.3 million for the year ended December 31, 2022. The increase was primarily attributable to higher portfolio balances and an increase in the average yield. The average yield increased to 8.34% from 7.77%. Average loans increased $633.0 million, or 20.5%, from $3.1 billion for the year ended December 31, 2022 to $3.7 billion for the year ended December 31, 2023. The increase in average yield is attributable to the overall higher interest rate environment in 2023.
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 ($633.0 million) by the previous period’s average yield (7.77%). Similarly, the effect of rate changes is calculated by multiplying the change in average yield (0.57%) by the current period’s average loan balance ($3.7 billion).
Years Ended December 31, 2023 and 2022
AverageLoans
InterestIncome
AverageYield
Year Ended December 31, 2023
Year Ended December 31, 2022
Volume variance
632,999
49,200
Rate variance
21,232
0.57
Total interest income variance
Interest Expense — Portfolio Related. Portfolio related interest expense consists of interest incurred on our warehouse facilities and securitized debt, which increased by $58.7 million, or 46.0%, to $186.5 million for the year ended December 31, 2023, from $127.7 million for the year ended December 31, 2022. The increase in portfolio related interest expense in 2023 was primarily attributable to a higher loan portfolio being financed and increased interest rates.
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, 2023 and 2022.
AverageDebt (1)
InterestExpense
Cost ofFunds
590,589
27,422
31,323
Total interest expense variance
Net Interest Income After Provision for Loan Losses
Net interest income after provision for loan losses increased 29.1% over the prior year driven by higher net interest income.
(12,916
(43.8
24,603
29.6
Provision for loan losses
763
66.2
23,840
29.1
Interest Expense — Corporate Debt. Corporate debt interest expense decreased by $12.9 million from $29.5 million for the year ended December 31, 2022 to $16.6 million for the year ended December 31, 2023 primarily due to the $12.8 million prepayment fee and write-off of unamortized debt issuance costs associate with the payoff of our previous corporate debt in March 2022. The corporate debt balance was $215.0 million as of December 31, 2023.
Provision for Loan Losses. Our provision for loan losses increased by approximately $0.8 million from the provision of $1.2 million for the year ended December 31, 2022 to a provision of $1.9 million for the year ended December 31, 2023. The increase in provision for loan losses is primarily attributable to the increase in charge-offs.
The table below presents the various components of other operating income for the year ended December 31, 2023 compared to the year ended December 31, 2022. The $41.6 million net increase is primarily due to the election of fair value option accounting on new loan originations beginning October 1,2022, and the fair value option accounting on most securitized debt issued effective January 1, 2023.
Gain on disposition of loans
8,238
7,107
1,131
15.9
Unrealized gain on fair value loans
47,850
8,265
39,585
478.9
Unrealized (loss)/gain on mortgage servicing rights
(660
2,086
(2,746
(131.6
Unrealized loss on fair value securitized debt
(9,002
Origination fee income
12,450
5,225
(1)
7,225
138.3
Interest income on cash balance
5,194
Other income
1,840
1,638
202
12.3
Total other operating income
41,589
171.0
28
The table below presents the various components of operating expenses for the year ended December 31, 2023 compared to the year ended December 31, 2022. Total operating expenses increased by 62.9%, or $38.9 million to $100.6 million during the year ended December 31, 2023 from $61.8 million during the year ended December 31, 2022. The increase was driven mainly by the FVO election for loans and securitizations. Under FVO accounting, direct compensation related to the origination of loans and securitization issuance costs are expensed as incurred. Under amortized cost accounting, these costs are deferred and amortized as yield adjustments for these products.
Compensation and employee benefits
48,344
30,458
17,886
58.7
Origination expenses
518
3,985
(3,467
(87.0
Securitization expenses
12,923
Loan servicing
17,631
12,298
5,333
43.4
Professional fees
4,599
4,179
420
10.1
Rent and occupancy
1,927
1,748
179
10.2
Real estate owned, net
6,153
(70
6,223
(8,890.0
Other operating expenses
8,524
9,166
(642
(7.0
61,764
38,855
62.9
Compensation and Employee Benefits. Compensation and employee benefits increased from $30.5 million during the year ended December 31, 2022 to $48.3 million during year ended December 31, 2023. The increase was mainly driven by the FVO accounting on all new loan originations beginning October 1, 2022, as all origination costs on FVO loans are expensed as incurred as opposed to being deferred and amortized prior to October 1, 2022 and to a lesser extent an increase in employees.
Origination Expenses. Origination expenses decreased from $4.0 million during the year ended December 31, 2022 to $0.5 million during the year ended December 31, 2023. The decrease of $3.5 million is primarily due to more effective loan origination cost management and our ability to transfer origination costs such as appraisal fees to borrowers.
Securitization Expenses. Securitization expenses are $12.9 million for the year ended December 31, 2023. Securitization expenses are due to the election of fair value option accounting on securitized debt issued in 2023. Securitization expenses on FVO securitized debt are expensed as incurred as opposed to being deferred and amortized for securitized debt carried at amortized cost.
Loan Servicing. Loan servicing expenses increased from $12.3 million during the year ended December 31, 2022 to $17.6 million during the year ended December 31, 2023. The $5.3 million increase during the year ended December 31, 2023 is mainly due to the increase in our total loan portfolio.
Professional Fees. Professional fees remained relatively consistent from $4.2 million for the year ended December 31, 2022 to $4.6 million for the year ended December 31, 2023.
Rent and Occupancy. Rent and occupancy expenses remained relatively consistent between $1.9 million and $1.7 million during the years ended December 31, 2023 and 2022, respectively.
Net Expenses of Real Estate Owned. Net expenses of real estate owned increased from an income of $70 thousand during the year ended December 31, 2022 to an expense of $6.2 million during the year ended December 31, 2023. The $6.2 million increase is mainly due to the increase in valuation adjustments taken.
Other Operating Expenses. Other operating expenses decreased from $9.2 million for the year ended December 31, 2022 to $8.5 million for the year ended December 31, 2023, mainly due to a decrease in marketing and advertising expense.
Income Tax Expense. Income tax expense was $18.8 million and $12.0 million for the year ended December 31, 2023 and 2022, respectively. Our annual consolidated effective tax rates were 25.2% and 27.2% for the years ended December 31, 2023 and 2022 respectively.
29
Year Ended December 31, 2022 Compared to Year Ended December 31, 2021
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 multiplying the change in average loan balance (i.e., $966.4 million) by the previous period’s average yield (i.e., 8.56%). Similarly, the effect of rate changes is calculated by multiplying the change in average yield (i.e., 0.79%) by the current period’s average loan balance (i.e., $3.1 billion).
Years Ended December 31, 2022 and 2021
Year Ended December 31, 2021
966,351
82,718
(24,343
(0.79
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.
936,774
44,093
(1,756
(0.06
30
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
7.5
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 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 $14.5 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.
7,892
(785
(9.9
%)
8,236
28400.0
Unrealized gain on mortgage servicing rights
0.0
1,610
3,615
224.5
1,637
267
1,370
513.1
24,320
14,522
148.2
31
Total operating expenses increased by 33.5%, or $15.5 million to $61.8 million during the year ended December 31, 2022 from $46.3 million during the year ended December 31, 2021. This increase was driven by higher origination activity as well as the fair value election for loans originated in the fourth quarter.
19,190
11,268
2,174
1,811
83.3
8,282
4,016
48.5
3,781
398
10.5
1,769
(21
(1.2
3,150
(3,220
(102.2
7,924
1,242
15.7
46,270
15,494
33.5
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 the 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.
Origination Expenses. Origination expenses increased from $2.2 million during the year ended December 31, 2021 to $4.0 million during the year ended December 31, 2022. The increase of $1.8 million is primarily due to an increase in appraisal costs on higher origination volume after a pandemic-impacted 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 2022 is mainly due to the increase in our loan portfolio.
Professional Fees. Professional fees increased from $3.8 million for the year ended December 31, 2021 to $4.2 million for the year ended December 31, 2022.
Rent and Occupancy. Rent and occupancy expenses remained relatively consistent at approximately $1.7 million to $1.8 million during the years ended December 31, 2022 and 2021.
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.
Other Operating Expenses. Other operating expenses slightly increased from $8.0 million for the year ended December 31, 2021 to $9.2 million for the year ended December 31, 2022 mainly due to an increase in 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.
32
Quarterly Results of Operations
The following table sets forth certain financial information for each completed fiscal quarter since the quarter ended March 31, 2022. 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 31,2023
September 30,2023
June 30,2023
March 31,2023
December 31,2022
September 30,2022
June 30,2022
March 31,2022
(unaudited)
86,269
79,088
74,897
70,521
65,632
63,419
59,243
52,049
51,405
47,583
45,451
42,029
40,854
34,561
28,752
23,556
34,864
31,505
29,446
28,492
24,778
28,858
30,491
28,493
3.52
3.24
3.23
2.84
3.59
4.10
4.25
4,140
4,138
4,139
4,011
4,182
17,140
30,724
27,367
25,307
24,353
20,639
24,847
26,309
11,353
3.10
2.90
2.78
2.36
3.09
3.54
1.69
827
154
298
636
(437
580
279
730
29,897
27,213
25,009
23,717
21,076
24,267
26,030
10,623
21,670
17,360
14,037
12,843
11,420
3,027
3,592
6,281
Operating expenses
29,260
27,334
22,222
21,803
20,804
13,245
14,832
12,883
22,307
17,239
16,824
14,757
11,692
14,049
14,790
4,021
Less income (loss) attributable to noncontrolling interest
(189
83
87
(235
307
126
110
5,141
5,070
4,602
3,465
3,759
4,019
790
17,355
12,086
12,183
10,649
8,462
9,983
10,645
3,121
Liquidity and Capital Resources
Sources and Uses of Liquidity
We fund our lending activities primarily through borrowings under our warehouse repurchase facilities, securitized debt, 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.
Our total liquidity plus available warehouse capacity was $617.4 million as of December 31, 2023 comprised of $40.7 million in cash, $22.5 million of available borrowings for unencumbered loans and $554.2 million of available warehouse capacity.
As of December 31, 2022, our total liquidity plus available warehouse capacity was $559.3 million, comprised of $45.2 million in cash, $14.0 million of available borrowings for unencumbered loans and $500.1 million of available warehouse capacity.
Cash and Cash Equivalents
During the year ended December 31, 2023, we used approximately $129 thousand of net cash and cash equivalents from operations, investing and financing activities. 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.
33
Warehouse Facilities
As of December 31, 2023, we had six 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 three agreements are three-year warehouse facilities. The borrowings are collateralized by primarily performing loans, one of the warehouse facilities bear interest at one-month AMERIBOR and six warehouse facilities at SOFR, all at margins that range from 1.60% to 4.50%. We also had a short term repurchase agreement with a maximum borrowing capacity of $30.5 million. Borrowing under these facilities was $336.4 million with $554.2 million of available capacity under our warehouse and repurchase facilities as of December 31, 2023.
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.
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, 2023, we were in compliance with these covenants.
From May 2011 through December 2023, we have completed 31 transactions, issuing $6.4 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, 2023 and 2022, the stated maturity for each securitized debt, the outstanding bond balances, and the weighted average rate on the securities for the Trusts as of December 31, 2023 and 2022, 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 securitized debt as long-term financing for our portfolio, and we do not plan to structure any securitized debt as sales or utilize off-balance-sheet vehicles. We believe any financing of assets and/or securitized debt we may undertake will be sufficient to fund our working capital requirements.
34
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
48,835
48,674
57,622
Investing activities
(584,732
(908,238
(656,483
Financing activities
535,768
874,016
626,172
Net change in cash, cash equivalents, and restricted cash
(129
14,452
27,311
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, 2023, our net cash provided by operating activities of $48.8 million consisted mainly of $52.3 million in net income, and $25.8 million proceeds from sales of loans held for sale, offset by $38.2 million of valuation gains.
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.
Investing Activities
For the year ended December 31, 2023, our net cash used in investing activities of $584.7 million consisted mainly of $1.1 billion in cash used to originate held for investment loans, offset by $459.7 million in cash received in payments on held for investment loans.
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.
Financing Activities
For the year ended December 31, 2023, our net cash provided by financing activities of $535.8 million consisted mainly of $1.2 billion in borrowings from our warehouse and repurchase facilities and $1.0 billion in securitizations issued, respectively. The cash generated was offset by payments we made of $1.2 billion and $438.8 million on our warehouse and repurchase facilities and securitizations issued, respectively.
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.
35
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.
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.
At-The-Market Equity Offering Program
On September 3, 2021, we entered into separate Equity Distribution Agreements with counterparties to establish an at-the-market equity offering program (“ATM Program”) where we may issue and sell, from time to time, shares of our common stock. Our ATM Program allows for aggregate gross sales of our common stock of up to $50,000,000 provided that the number of shares sold under the ATM Program does not exceed 5,000,000. During the year ended December 31, 2023, 29,343 shares of common stock were sold under our ATM Program for net proceeds of $348.6 thousand.
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.
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, 2023, 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, 2023, we maintained warehouse facilities to finance our investor real estate loans and had approximately $336.4 million in outstanding borrowings with $554.2 million of available capacity under our warehouse and repurchase facilities.
36
The following table illustrates our contractual obligations existing as of December 31, 2023:
January 1, 2024 -
January 1, 2025 -
December 31, 2024
December 31, 2026
Thereafter
Total
336,351
Notes payable (corporate debt)
Leases payments under noncancelable operating leases
1,289
838
1,127
3,254
337,640
216,127
554,605
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
In December 2023, the FASB issued ASU 2023-09, “Income Taxes (Topic 240): Improvements to Income Tax Disclosures,” which requires additional disclosure and disaggregated information in the Income Tax Rate reconciliation using both percentages and reporting currency amounts, with additional qualitative explanations of individually significant reconciling items. The updated guidance also requires disclosure of the amount of income taxes paid (net of refunds received) disaggregated by jurisdictional categories (federal (national), state, and foreign). The accounting update is effective for January 1, 2025 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, 2023, 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, 2023, 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, 2023.
The effectiveness of our internal control over financial reporting as of December 31, 2023 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, 2023, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 9B. Other Information.
(a) None.
(b) None.
Item 9C. Disclosure Regarding Foreign Jurisdictions that Prevent Inspections.
Item 10. Directors, Executive Officers and Corporate Governance.
Information with respect to this item will be contained in our Proxy Statement for our 2024 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
3.2
Restated Certificate of Incorporation of Velocity Financial, Inc.
5/23/2022
3.3
Amended and Restated Bylaws of Velocity Financial, Inc.
3/25/2022
4.1
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
Stockholders Agreement dated as of January 16, 2020
Registration Rights Agreement dated as of January 16, 2020
10.3
Registration Rights Agreement dated as of April 7, 2020
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
10.7
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
1.1
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.
10.19
Velocity Financial, Inc. Incentive Compensation Clawback Policy*
99
2/7/2024
21.1
List of Subsidiaries of the Registrant
23.1
Consent of RSM US 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, 2023 and 2022 (ii) the Consolidated Statements of Income for the year December 31, 2023, 2022, and 2021, (iii) the Consolidated Statements of Changes in Stockholders’ Equity for the year December 31, 2023, 2022, and 2021, (iv) the Consolidated Statements of Cash Flows for the year December 31, 2023, 2022, and 2021 and (v) the Notes to unaudited Consolidated Financial Statements.
101.INS
Inline XBRL Instance Document
101.SCH
Inline XBRL Taxonomy Extension Schema Document With Embedded Linkbase Documents
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.
Item 16. Form 10-K Summary.
VELOCITY FINANCIAL, INC. AND SUBSIDIARIES
Index to Consolidated Financial Statements
Reports of Independent Registered Public Accounting Firm (RSM US LLP: PCAOB ID No. 49)
F-2
Consolidated Balance Sheets as of December 31, 2023 and 2022
F-7
Consolidated Statements of Income for the years ended December 31, 2023, 2022 and 2021
F-9
Consolidated Statements of Comprehensive Income for the years ended December 31, 2023, 2022, and 2021
F-10
Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2023, 2022 and 2021
F-11
Consolidated Statements of Cash Flows for the years ended December 31, 2023, 2022 and 2021
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, 2023 and 2022, the related consolidated statements of income, comprehensive income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2023, 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, 2023 and 2022, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2023, 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, 2023, 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 15, 2024, 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 audit 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 certain of its securitized debt issued after January 1, 2023 at fair value. The 2023 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 $4.8 million as of December 31, 2023. 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 each segment’s annual average loss rates for 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 then applied to an individual loan in each segment and considers the principal amortization using contractual maturity, factoring in further principal reductions from estimated prepayments.
Significant variables or assumptions incorporated in the macroeconomic forecasts include U.S. unemployment, treasury yields, U.S. real gross domestic product, and U.S. real estate housing prices. 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, 2023.
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:
Accounting for loans held for investment at fair value – significant assumptions used in the valuation model that are unobservable inputs
As described in Notes 2, 6 and 28 to the financial statements, the Company has elected the fair value option to measure all loans held for investment originated or acquired on or after October 1, 2022, at fair value. As of December 31, 2023, loans held for investment, at fair value, were $1.3 billion.
F-3
The Company used an in-house loan valuation model to estimate the fair value of its performing loans. 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 discount rate, constant prepayment rate, constant default rate and loss severity rate. The Company utilized a third-party valuation model that used unobservable inputs to estimate the fair value of nonperforming loans, and significant unobservable inputs used in the third-party model include interest rates, market yield requirements, probability of default, loss given default, voluntary prepayment speed and loss timing.
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 15, 2024
F-4
Opinion on the Internal Control Over Financial Reporting
We have audited Velocity Financial, Inc. and its subsidiaries’ internal control over financial reporting as of December 31, 2023, 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, 2023, 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 sheets of the Company as of December 31, 2023 and 2022, the related consolidated statements of income, comprehensive income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2023, and the related notes to the consolidated financial statements of the Company and our report dated March 15, 2024 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.
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-5
F-6
CONSOLIDATED BALANCE SHEETS
December 31, 2023 and 2022
(In thousands)
ASSETS
Cash and cash equivalents
40,566
45,248
Restricted cash
21,361
16,808
Loans held for sale, at fair value
17,590
2,828,123
3,272,390
Loans held for investment, at fair value
1,306,072
276,095
Total loans, net
4,151,785
Accrued interest receivables
27,028
20,463
Receivables due from servicers
85,077
65,644
Other receivables
8,763
1,075
44,268
13,325
Property and equipment, net
2,785
3,356
Deferred tax asset
2,339
5,033
Mortgage servicing rights, at fair value
8,578
9,238
Goodwill
6,775
Other assets
5,248
13,525
Total assets
4,404,573
3,748,975
LIABILITIES
Accounts payable and accrued expenses
121,969
91,525
Secured financing, net
211,083
209,846
Securitized debt, net
2,418,811
2,736,290
Securitized debt, at fair value
877,417
Warehouse and repurchase facilities, net
334,755
330,814
Derivative liability
3,665
Total liabilities
3,967,700
3,368,475
Commitments and contingencies
EQUITY
Common stock ($0.01 par value, 100,000,000 shares authorized; 32,987,248 and 32,523,516 shares issued, 32,865,836 and 32,489,869 shares outstanding at December 31, 2023 and 2022, respectively)
331
326
Additional paid-in capital
306,736
300,310
Retained earnings
128,906
76,633
Treasury stock, at cost (121,412 and 33,647 common shares at December 31, 2023 and 2022, respectively)
(1,319
(458
Accumulated other comprehensive loss
(1,210
Total Velocity Financial Inc. stockholders' equity
433,444
376,811
Noncontrolling interest in subsidiary
3,429
3,689
Total equity
436,873
380,500
Total liabilities and equity
See accompanying notes to consolidated financial statements.
CONSOLIDATED BALANCE SHEETS (CONTINUED)
The following table presents the assets and liabilities of our consolidated variable interest entities:
11,428
2,968
3,720,506
3,108,316
Accrued interest and other receivables
104,663
77,191
36,133
10,380
3,872,739
3,198,870
74,153
50,169
3,296,228
3,370,381
2,786,459
F-8
CONSOLIDATED STATEMENTS OF INCOME
For the years ended December 31, 2023, 2022 and 2021
(In thousands, except per share amounts)
Interest expense — portfolio related
Net interest income — portfolio related
Interest expense — corporate debt
Unrealized (loss) gain on mortgage servicing rights
Net earnings allocated to common shareholders
20,635
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the Years Ended December 31,
Other comprehensive income, net of tax:
Unrealized loss on cash flow hedges
1,160
Reclassification of derivative gain to income
50
Total other comprehensive loss, net of tax
1,210
Total comprehensive income attributable to Velocity Financial, Inc.
51,063
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
($ In thousands)
Common Stock
Treasury Stock
Shares
Par Value
AdditionalPaid-inCapital
RetainedEarnings
Amount
Accumulated Other Comprehensive Loss, net of tax
TotalStockholders'Equity
Non-Controlling Interest
Total Equity
Balance – December 31, 2020
20,087,494
201
204,190
15,198
219,589
Issuance of common stock
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
3,381
Balance – December 31, 2021
32,293,042
323
296,364
44,422
341,109
344,490
74,009
606
607
Purchase of treasury stock at cost
(33,647
Restricted stock awarded and stock-based compensation expenses
156,465
3,340
3,342
Balance – December 31, 2022
32,523,516
233,966
2,443
2,446
(87,765
(861
229,766
3,983
Distribution to non-controlling interest
(280
Other comprehensive loss
Balance – December 31, 2023
32,987,248
(121,412
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
752
796
1,119
Amortization of right-of-use assets
1,545
1,320
1,292
Origination of loans held for sale
(38,036
(31,255
Proceeds from sales of loans held for sale
25,817
32,156
Purchase of held for sale loans
(1,500
Repayments on loans held for sale
2,673
Net accretion of discount on purchased loans and deferred loan origination costs
4,813
7,009
6,519
Provision for (reversal of) uncollectible borrower advances
721
(175
(80
(826
(3,699
(6,776
Real estate acquired through foreclosure in excess of recorded investment
(7,412
(3,408
(1,117
Amortization of debt issuance discount and costs
18,624
28,294
20,224
Loss on disposal of property and equipment
Change in valuation of real estate owned
3,903
364
1,759
Change in valuation of fair value loans
(47,850
(8,265
(29
Change in valuation of held for sale loans
(17
Change in valuation of mortgage servicing rights
660
(2,086
Change in valuation of fair value securitized debt
9,002
Gain on sale of real estate owned
(568
(2,939
(409
Stock-based compensation
4,128
3,343
2,159
Deferred tax expense (benefit)
2,694
11,571
(9,950
Change in operating assets and liabilities:
(13,393
(7,421
(3,287
8,361
(8,043
(360
21,692
(2,562
16,452
Net cash provided by operating activities
Cash flows from investing activities:
Purchase of loans held for investment
(13,823
(18,231
(20,586
Origination of loans held for investment
(1,079,811
(1,739,572
(1,344,027
Proceeds from sales of loans originally classified as held for investment
21,485
292,472
135,787
Payments of loans held for investment and loans at fair value
459,681
541,676
568,837
Proceeds from sale of real estate owned
21,747
22,497
9,637
Purchase of real estate owned
(2,250
Capitalized real estate owned improvements
(194
Change in advances
(3,039
(5,414
(5,429
Change in impounds and deposits
9,208
910
9,202
Purchase of property and equipment
(180
(326
(135
Proceeds from sale of investments
1,180
Acquisition of Century, net of cash acquired
(10,755
Net cash used in investing activities
Cash flows from financing activities:
Warehouse and repurchase facilities advances
1,192,999
1,687,005
1,215,971
Warehouse and repurchase facilities repayments
(1,191,642
(1,658,065
(989,374
Proceeds from secured financing
175,000
Repayment of secured financing
(170,844
(82,156
Proceeds of securitized debt, net
975,072
1,369,985
977,678
Repayment of securitized debt
(438,763
(543,620
(643,500
Debt issuance costs
(3,062
(25,594
(27,024
2,305
137
Deferred stock issuance costs
(560
Purchase of treasury stock
Net cash provided by financing activities
Net (decrease) increase in cash, cash equivalents, and restricted cash
Cash, cash equivalents, and restricted cash at beginning of year
62,056
47,604
20,293
Cash, cash equivalents, and restricted cash at end of year
61,927
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Supplemental cash flow information:
Cash paid during the year for interest
180,364
118,711
85,019
Cash paid during the year for income taxes
7,648
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
Transfer of loans held for investment to real estate owned
48,614
10,031
11,466
Capitalized interest on loans held for investment
2,395
1,399
2,046
Transfer of loans held for sale to held for investment
16,246
77,190
11,137
Discount on issuance of securitized debt
1,636
23,398
2,051
Recognition of new leases in exchange for lease obligations
1,689
Preferred stock conversion to common stock
90,000
Business combination:
Investment securities
1,181
Fair value of tangible asset acquired
688
Mortgage servicing rights
7,152
Liabilities assumed
1,814
F-13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2023, 2022, and 2021
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 2017-2 Trust through and including the 2023-4 Trust, all of which are New York common law trusts, with the exception of the VCC 2022-MC1 Trust, VCC 2023-1R Trust, and VCC 2023-RTL1 Trust which are Delaware statutory trusts. 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, 2023.
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, 2023 and 2022, 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.
Reclassifications
Certain amounts previously reported have been reclassified to conform to the current year presentation. These reclassifications had no effect on the previously reported net 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, funds in the 2023-RTL 1 Trust escrow account, 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 October 1, 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. Century will continue to service the loans 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 its 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.
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.
F-17
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 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 2012-2023 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, 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.
For the December 31, 2023, 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. Management concluded that applying the severe stress scenario was appropriate given the continued inflation in the United States, the wars between Russia/Ukraine and Israel/Hamas, continued disruption in the supply chain, and concerns of a recession.
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 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.
F-18
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 and Vintage Disclosures: ASU 2022-02 “Financial Instruments-Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures” eliminates the Troubled Debt Restructurings (“TDR”) accounting model for creditors that have already adopted ASC 326. In lieu of the TDR accounting model, loan refinancing and restructuring guidance in ASC Subtopic 310-20 “Investments-Debt Securities” will apply to all loan modifications, including those made for borrowers experiencing financial difficulty. This standard also enhances disclosure requirements related to certain loan modifications. Additionally, this standard introduces new requirements to disclose gross write-off information in the vintage disclosures of financing receivables by credit quality indicator and class of financing receivable by year of origination. The Company adopted the standard on January 1, 2023.
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.
F-19
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, 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.
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 is determined based on the Company’s 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.
F-20
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.
The Company has elected to apply fair value option ("FVO") accounting to originated mortgage loans on a go-forward basis beginning October 1, 2022. The fair value option loans are presented on a separate line item in the consolidated balance sheet. Interest income on FVO loans is recorded on an accrual basis in the consolidated statements of income under the heading interest income. The Company will not record a CECL loan loss reserve on fair value option loans.
The Company has elected to apply FVO accounting to securitized debt issued effective January 1, 2023, when the underlying collateral is also carried at fair value. The FVO securitized debt is presented on a separate line item in the consolidated balance sheet. The Company reflects interest expense on the fair value option securitized debt as interest expense - portfolio related in the consolidated statements of income and presents the other fair value changes of the FVO securitized debt separately in the consolidated financial statements.
Derivative Instruments and Hedge Accounting
The Company issues fixed rate debt at regular intervals during the year through the securitization of its fixed rate mortgage assets. The Company is subject to interest rate risk on its forecasted debt issuances as these fixed rate debt issuances are priced at then-current market rates. The Company’s risk management objective is to hedge the risk of variability in its interest payment cash flows attributable to changes in the benchmark Secured Overnight Financing Rate ("SOFR") between the time the fixed rate mortgages are originated and the fixed rate debt is issued. To accomplish this hedging strategy, the Company may from time to time enter into derivative instruments such as forward starting payer interest rate swaps or interest rate payer swaptions designated as cash flow hedges that are designed to be highly correlated to the underlying terms of the forecasted debt instruments. To qualify for hedge accounting, the Company formally documents its hedging relationships at inception, including the identification of the hedging instruments and the hedged items, as well as its risk management objectives and strategies for undertaking the hedge transaction at the time the derivative contract is executed. The Company also formally assesses effectiveness both at the hedge's inception and on an ongoing basis.
The Company's policy is to present all derivative balances on a gross basis, without regard to counterparty master netting agreements or similar arrangements. The fair value of the derivative instruments is recorded as a separate line item on the consolidated balance sheets as an asset or liability with the related gains or losses reported as a component of accumulated other comprehensive income ("AOCI"). Beginning in the period in which the forecasted debt issuance occurs and the related derivative instruments are terminated, the gains or losses accumulated in AOCI are then reclassified into interest expense as a yield adjustment over the term of the related debt. If the Company determines it is not probable that the forecasted transaction will occur, gains and losses are reclassified immediately to earnings. The related cash flows are recognized on the cash flows from operating activities section on the consolidated statements of cash flows. The Company uses hedge accounting based on the exposure being hedged as cash flow hedges in operations.
Other Comprehensive Income
Other comprehensive income ("OCI") is reported in the consolidated statements of comprehensive income. OCI is comprised of net income and the effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges, net of tax, less amounts reclassified into earnings.
Accumulated other comprehensive income represents the cumulative balance of OCI, net of tax, as of the end of the reporting period and relates to unrealized gains or losses on cash flow hedges, net of tax.
F-21
Note 3 — Current Accounting Developments
Recently Issued Accounting Standards
In December 2023, the FASB issued ASU 2023-09, “Income Taxes (Topic 240): Improvements to Income Tax Disclosures,” which requires additional disclosure and disaggregated information in the Income Tax Rate reconciliation using both percentages and reporting currency amounts, with additional qualitative explanations of individually significant reconciling items. The updated guidance also requires disclosure of the amount of income taxes paid (net of refunds received) disaggregated by jurisdictional categories (federal (national), state, and foreign). The accounting update is effective January 1, 2025, for the Company. The adoption of this standard is not expected to have a significant impact on the Company’s consolidated financial statements.
Recently Adopted Accounting Standard
Financial Instruments - Credit Losses
Effective January 1, 2023, the Company adopted 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. The adoption of this standard did not have a significant impact on the Company’s consolidated financial statements.
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 $79.7 million and $68.5 million as of December 31, 2023 and 2022, respectively.
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, 2023, 2022, and 2021 (in thousands):
35,965
11,639
Total cash, cash equivalents, and restricted cash shown in the consolidated statements of cash flows
Note 5 — Loans Held for Sale at Fair Value
The following table summarizes loans held for sale at fair value as of December 31, 2023 and 2022 (in thousands):
16,954
Valuation adjustments on FVO loans held for sale
F-22
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, 2023 and 2022 (in thousands):
Loans held for
investment,
investment, at
held for
net
fair value
investment
1,251,395
2,832,892
Allowance for loan losses
Total loans held for investment, net
268,632
3,277,283
During the years ended December 31, 2023, 2022, and 2021, $201.0 million, $292.4 million, and $394.7 million, respectively, in UPB of loans held for investment have participated in the COVID-19 forbearance program and the Company granted a 90-days forbearance period on these loans. The following tables summarize the activity, the UPB, and amortized cost basis of the loans in the Company's COVID-19 forbearance program for the years ended December 31, 2023 and 2022 ($ in thousands):
Amortized Cost
203,346
Foreclosures
(833
(830
Repayments
(25,601
(26,001
176,515
Performing/Accruing
75.8%
133,771
Nonperforming/Nonaccrual
24.2%
42,744
295,990
(3,593
(3,620
(87,831
(89,024
161,455
80.3%
163,346
39,550
19.7%
40,000
Since April 1, 2020, the inception of the COVID-19 forbearance program, the Company has modified $411.7 million in UPB of loans, which includes capitalized interest of $13.6 million. As of December 31, 2023, $241.7 million in UPB of modified loans has been paid down, which includes $4.8 million of capitalized interest received.
Approximately 75.8% and 80.3% of the COVID forbearance loans in UPB were performing, and 24.2% and 19.7% were on nonaccrual status as of December 31, 2023 and 2022, respectively.
F-23
As of December 31, 2023 and 2022, the gross unpaid principal balance of loans held for investment pledged as collateral for the Company’s warehouse facility agreements, and securitized debt issued were as follows (in thousands):
The 2013 repurchase agreement
132,505
170,185
The 2021 repurchase agreement
103,787
101,024
The Bank credit agreement
39,619
39,087
The 2021 term repurchase agreement
41,628
104,594
The July 2021 term repurchase agreement
30,923
3,859
The 2023 repurchase agreement
29,501
Total pledged loans
377,963
418,749
2016-1 Trust
39,720
2017-2 Trust
50,554
67,048
2018-1 Trust
37,810
48,139
2018-2 Trust
85,122
104,791
2019-1 Trust
87,677
104,249
2019-2 Trust
73,166
91,025
2019-3 Trust
64,403
75,618
2020-1 Trust
116,843
144,913
2020-2 Trust
69,085
81,259
2021-1 Trust
182,184
208,875
2021-2 Trust
148,989
172,144
2021-3 Trust
159,565
178,861
2021-4 Trust
245,945
275,741
2022-1 Trust
245,372
262,526
2022-2 Trust
222,333
245,339
2022-MC1 Trust
73,840
97,246
2022-3 Trust
278,268
299,638
2022-4 Trust
298,758
326,627
2022-5 Trust
223,112
251,288
2023-1 Trust
217,220
2023-2 Trust
214,221
2023-3 Trust
255,699
2023-RTL1 Trust
79,465
2023-4 Trust
227,940
3,657,571
3,075,047
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, 2023 and 2022.
Total Nonaccrual
Nonaccrual with No Allowance for Loan Loss
Nonaccrual with Allowance for Loan Loss
Allowance for Loans Individually Evaluated
Commercial - Purchase
28,221
27,037
1,184
156
Commercial - Refinance
86,890
84,575
2,315
444
Residential 1-4 Unit - Purchase
36,253
Residential 1-4 Unit - Refinance
137,925
134,579
3,346
245
Short Term 1-4 Unit - Purchase
6,402
6,403
Short Term 1-4 Unit - Refinance
29,663
27,059
2,604
129
325,354
315,906
9,449
974
F-24
22,571
22,437
134
87,133
82,330
4,803
517
27,984
27,516
468
118
113,909
111,742
2,167
175
8,140
35,602
30,612
4,990
258
295,339
282,777
12,562
1,096
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.
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, 2023 and 2022, and the amount of accrued interest receivable written off by reversing interest income by portfolio segment loans that have been placed on nonaccrual for the years ended December 31, 2023 and 2022 (in thousands):
Interest Reversal
631,925
(788
701,408
(640
799,816
(2,084
907,097
(1,343
511,080
(1,239
588,433
(596
808,149
(2,918
939,305
(1,602
41,111
(174
69,884
40,811
(459
71,157
(502
(7,662
3,277,284
(4,872
For the years ended December 31, 2023 and 2022, cash basis interest income recognized on nonaccrual loans was $30.6 million and $27.3 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, 2023 and 2022. The average recorded investment of individually evaluated loans, computed using month-end balances, was $331.4 million and $269.4 million for the years ended December 31, 2023 and 2022, respectively. There were no commitments to lend additional funds to debtors whose loans have been modified as of December 31, 2023 and 2022.
F-25
The following tables present the activity in the allowance for loan losses for the years ended December 31, 2023 and 2022 (in thousands):
Residential
Short Term
Commercial
1-4 Unit
Purchase
Refinance
Balance - January 1, 2023
639
2,031
542
1,272
388
296
180
(5
1,050
Charge-offs, net
(232
(137
(11
(386
(1,273
935
1,805
585
1,256
Allowance related to:
Loans individually evaluated
Loans collectively evaluated
779
1,361
1,011
3,795
Amortized cost related to:
603,704
712,926
474,827
670,224
34,709
11,148
2,507,538
Balance - January 1, 2022
385
2,144
400
948
43
342
401
(88
149
429
(22
283
(147
(25
(7
(105
(237
611
1,514
424
1,097
130
3,797
678,837
819,964
560,449
825,396
61,744
35,555
2,981,945
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 0.62%, 0.20%, and 0.42% for the years ended December 31, 2023, 2022 and 2021, respectively.
F-26
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 $176.5 million and $203.3 million loans in the Company’s COVID-19 forbearance program as of December 31, 2023 and 2022, respectively (in thousands):
30–59 days
60–89 days
90+days
past due
past due(1)
loans
2,329
668
25,224
4,716
2,405
79,769
544
35,709
2,988
1,923
133,014
55
29,608
Total loans individually evaluated
10,632
4,996
309,726
21,342
8,352
29,694
574,010
47,430
14,002
61,432
651,494
29,236
6,850
36,086
438,741
52,510
20,828
73,338
596,886
1,169
658
1,827
32,882
2,978
213
3,191
7,957
Total loans collectively evaluated
154,665
50,903
205,568
2,301,970
165,297
55,899
530,922
865
21,706
4,415
5,943
76,619
86,977
590
592
26,802
1,715
2,728
109,466
176
7,964
657
34,945
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
181,198
64,314
245,512
2,736,433
189,616
73,577
540,695
2,736,589
F-27
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, 2023 and 2022 (in thousands):
2,803
349
17,054
17,403
523
467
12,910
14,156
7,860
816
41,150
42,745
1,016
1,959
2,975
16,608
19,583
8,102
1,433
9,535
47,257
56,792
1,615
227
1,842
8,808
10,650
1,423
789
2,212
21,462
23,674
23,071
12,156
4,408
16,564
117,206
133,770
12,972
5,187
59,309
2,880
767
186
16,194
17,147
10,039
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
1,539
5,657
30,178
35,835
19,832
33,852
7,017
40,869
122,477
34,799
7,203
80,869
F-28
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, 2023 and 2022 (in thousands).
Term Loans Amortized Cost Basis by Origination Year
December 31, 2023:
2020
2019
Pre-2019
Payment performance
Performing
248,153
226,467
31,692
43,829
53,563
Nonperforming
9,600
6,104
567
4,773
7,177
Total Commercial - Purchase
257,753
232,571
32,259
48,602
60,740
233,052
188,723
47,883
92,819
150,449
20,462
14,168
4,207
14,167
33,886
Total Commercial - Refinance
253,514
202,891
52,090
106,986
184,335
208,456
198,110
9,581
24,429
34,251
17,287
10,740
701
1,421
Total Residential 1-4 Unit - Purchase
225,743
208,850
10,282
25,850
40,355
277,980
237,159
19,752
61,136
74,197
43,272
36,344
7,835
28,252
Total Residential 1-4 Unit - Refinance
321,252
273,503
27,587
89,388
96,419
11,458
18,510
4,561
5,533
704
Total Short Term 1-4 Unit - Purchase
16,991
345
19,214
4,313
153
7,435
13,612
4,150
Total Short Term 1-4 Unit - Refinance
15,461
Total Portfolio
1,090,714
918,313
148,867
288,999
385,999
Gross charge-offs - quarter-ended December 31, 2023
744
Gross charge-offs - year-ended December 31, 2023
1,120
473
446
2,039
F-29
December 31, 2022:
2018
Pre-2018
273,950
249,100
36,064
56,322
33,193
30,208
1,274
6,959
1,579
5,809
3,205
3,745
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
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
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
360,350
310,218
31,610
111,954
55,704
69,469
40,967
944
15,659
4,174
1,287
5,212
995
42,254
6,156
16,654
786
1,221
10,545
18,245
4,805
36,341
1,243,841
1,033,695
168,977
358,100
231,024
241,647
F-30
The following table presents the aggregate fair value of loans held for investment at fair value that are 90 days or more past due and/or in nonaccrual status, and the difference between the aggregate fair value and the aggregate unpaid principal balance as of December 31, 2023, by loan segments (in thousands):
Fair Value
Unpaid Principal Balance
Difference
Current–89 days
90+days past due
or nonaccrual
204,282
4,651
208,933
188,924
5,635
194,559
(984
230,034
7,399
237,433
210,716
8,962
219,678
(1,563
238,215
12,886
251,101
231,494
15,428
246,922
(2,542
472,615
29,335
501,950
448,780
35,119
483,899
(5,784
46,312
48,081
45,695
2,143
47,838
(374
54,041
4,533
58,574
53,008
5,491
58,499
(958
1,245,499
60,573
1,178,617
72,778
(12,205
F-31
Note 7 — Mortgage Loans on Real Estate
The following tables present the Company’s loans (UPB) collateralized by real estate as of December 31, 2023 and 2022 (in thousands).
Description
InterestRate
FinalMaturityDate
UnpaidPrincipalBalance(1)(2)
Nonaccrual UnpaidPrincipalBalance
1-4 unit residential (3)
Under $1.0 million
4.0% - 15.0%
January 1, 2054
1,674,434
185,391
$1.0 million and over
4.0% - 13.2%
567,314
80,976
2,241,748
266,367
Traditional commercial (4)
4.0% - 14.0%
1,322,387
86,755
4.0% - 13.3%
508,755
41,440
1,831,142
128,195
Total at December 31, 2023
4.0% - 13.5%
January 1, 2053
1,374,726
127,125
4.0% - 11.5%
476,813
57,508
1,851,539
184,633
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
The following table presents the reconciliation of the UPB of mortgage loans for the years ended December 31, 2023, 2022, and 2021:
Balance at beginning of period
2,587,220
1,944,804
Addition during period:
New mortgage loans
1,117,846
Acquisition
13,075
17,657
Capitalized Interest
1,604
2,045
Deduction during period:
Collection of principal
(474,406
(525,986
(568,081
Collection of capitalized interest
(570
(2,155
(2,163
(52,208
(10,031
(11,603
Mortgages sold
(45,728
(317,676
(126,494
Balance at end of period
F-32
Note 8 — Receivables Due from Servicers
The following tables summarize receivables due from servicers as of December 31, 2023 and 2022 (in thousands):
Warehouse and repurchase facilities and other
Loan principal payments due from servicers
41,289
136
41,425
Other loan servicing receivables
13,122
3,249
16,371
Loan servicing receivables
54,411
3,385
57,796
Corporate and escrow advances receivable
25,736
27,281
Total receivables due from servicers
80,147
4,930
24,400
664
25,064
13,095
2,521
15,616
37,495
3,185
40,680
21,995
2,969
24,964
59,490
6,154
Note 9 — Property and Equipment, Net
As of December 31, 2023 and 2022, property and equipment consisted of the following (in thousands):
Furniture
930
927
Computer equipment
986
Office equipment
Leasehold improvements
609
Capitalized software
6,784
6,671
Building
685
10,403
10,256
Accumulated depreciation and amortization
(7,618
(6,900
During the years ended December 31, 2023, 2022 and 2021, depreciation and amortization expense was $0.8 million, $0.8 million, and $1.1 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, 2023 and 2022. Total accumulated depreciation and amortization included accumulated amortization on the data warehouse and the LOS of $4.4 million and $4.1 million as of December 31, 2023 and 2022, respectively. The estimated aggregate amortization expense related to capitalized software for each of the next five years is $0.4 million for 2024, 2025, 2026, $0.2 million for 2027, and $0.1 million for 2028.
F-33
Note 10 — Real Estate Owned, Net
The Company’s real estate owned activities were as follows during the years ended December 31, 2023, 2022, and 2021 (in thousands):
17,557
15,767
Additions
56,025
13,439
12,583
Capitalized improvements
194
Sales
(21,179
(19,558
(9,228
Other adjustments
2,250
Valuation adjustments
(363
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, 2023, 2022 and 2021 (in thousands):
Operating income
275
451
(2,818
(2,781
(2,251
Net gain on sales of real estate
(6,153
70
(3,150
Net gain 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, 2023, 2022 and 2021 (in thousands, except properties sold):
Gain
sold
(loss)
Sales resulting in gains
1,442
3,401
972
Sales resulting in losses
(874
(462
(563
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 $490.9 million and $491.9 million as of December 31, 2023, and 2022, 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, 2023, 2022, and 2021 include: 1) Weighted average discount rate of 8.0%, 8.1%, and 8.0%, respectively; 2) Weighted average constant prepayment rate of 6.5%, 6.3%, and 3.2%, respectively.
The following table presents the Company's mortgage servicing rights for the years ended December 31, 2023, 2022, and 2021 (in thousands):
Balance at the beginning of year
Mortgage servicing rights acquired
250
Fair value adjustments
(910
Balance at end of year
F-34
Note 12 — Derivative Instruments
In September 2023, the Company began utilizing forward starting interest rate swap derivative instruments designated as cash flow hedges to manage the exposure to interest rate volatility related to its forecasted issuances of fixed-rate debt through its securitization process. The Company’s risk management objective is to hedge the risk of variability in its interest payment cash flows attributable to changes in the benchmark Secured Overnight Financing Rate ("SOFR") between the time the fixed rate mortgages are originated and the fixed rate debt is issued. As of December 31, 2023, the maximum length of time over which the Company was hedging its exposure to variability in future cash flows for forecasted transactions did not exceed four years.
The gains or losses on the derivative instruments that are designated and qualify as cash flow hedges are reported as a component of AOCI. Beginning in the period in which the forecasted debt is issued and the related derivative instruments are terminated, the accumulated gains or losses associated with the terminated derivatives are then reclassified into interest expense as a yield adjustment over the term of the related debt. For the year ended December 31, 2023, $50 thousand gain on terminated derivative instruments was reclassified from AOCI to interest expense. As of December 31, 2023, the Company had $1.2 million in after-tax net unrealized loss associated with cash flow hedging instruments recorded in AOCI. As of December 31, 2023, the Company expects to reclassify an estimated $0.3 million of after-tax net unrealized losses on derivative instruments designated as cash flow hedges from AOCI into earnings over the next 12 months.
The following table presents the fair value of the Company’s derivative financial instruments on a gross basis, as well as its classification on the Company’s consolidated balance sheets as of December 31, 2023:
Fair Value (1)
Derivatives designated as hedging instruments:
Balance Sheet Location
Notional Amount
Derivative Assets
Derivative Liabilities
Cash flow hedges:
Forward starting payer interest rate swaps
166,000
(3,665
The counterparty to the financial derivatives that the Company enters into is a major institution. The Company is exposed to credit-related losses in the event of non-performance by the counterparty. This credit risk is generally limited to the unrealized gains in such contracts, less collateral held, should the counterparty fail to perform as contracted.
Note 13 — Accumulated Other Comprehensive Loss
The following table presents the changes in the component of accumulated other comprehensive loss balances for the years ended December 31, 2023, 2022, and 2021:
Net unrealized loss on cash flow hedges arising during the period, net of tax
Reclassification of derivative instruments to income
The following table presents the component of other comprehensive loss and the related tax effect for the year ended December 31, 2023:
F-35
Before-Tax
Tax Effect
Net-of-Tax
Forward starting payer interest rate swaps:
Net unrealized loss arising during the period
1,568
408
Reclassification to income
69
Note 14 — 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, 2023 and 2022.
The following table presents the activity for goodwill (in thousands):
Goodwill acquired
Note 15 — Other Assets
Other assets were comprised of the following as of December 31, 2023 and 2022 (in thousands):
Prepaid expenses
2,026
1,843
Deposits
190
Deferred costs
500
501
Income tax receivable
8,301
Operating leases - right of use assets, net
2,544
2,424
Appraisal fees for loans in process
(172
(58
160
338
Total other assets
Note 16 — 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.
F-36
The Company uses its incremental borrowing rates to determine the present value of its lease liabilities. The weighted average borrowing rate was 7.72%, 5.88%, and 5.86% as of December 31, 2023, 2022, and 2021, respectively. The Company’s leases have remaining terms ranging from 2 years to 5 years, and the weighted average remaining lease term was 4.3 years as of December 31, 2023. 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.
As of December 31, 2023, and 2022, operating lease ROU assets included in other assets was $2.5 million and $2.4 million, respectively. Operating lease liabilities included in accounts payable and accrued expenses remained at $2.7 million as of December 31, 2023, and 2022, respectively. Operating lease expense is a component of “Rent and occupancy” expense on the consolidated statements of income. Operating lease expense was $1.9 million, $1.7 million, and $1.8 million for the year ended December 31, 2023, 2022, and 2021, respectively, and included short-term leases that were immaterial.
The following table presents supplemental cash flow information related to leases for the years ended December 31, 2023, 2022, and 2021 (in thousands):
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases
1,632
1,626
ROU assets obtained in exchange for lease obligations:
Operating leases
256
The following table presents maturities of operating lease liabilities as of December 31, 2023 (in thousands):
Operating Leases
2024
2025
2026
325
2027
277
2028
233
617
Total lease payments
Less: Imputed interest
(553
Present value of lease liabilities
2,701
Note 17 — Securitized Debt and Securitized Debt at Fair Value
The following tables summarize securitized debt and securitized debt at fair value as of December 31, 2023 and 2022 ($ in thousands):
Securitized debt at fair value
Total securitized debt
2,458,439
876,704
3,335,143
Valuation adjustments on FVO securitized debt
713
Deferred issuance costs and discounts
(39,628
Total securitized debt and securitized debt at fair value
F-37
2,788,908
(52,618
The difference between the aggregate fair value and aggregate UPB of securitized debt at fair value as of December 31, 2023, was $0.7 million.
The following table presents the effective interest rate of securitized debt and securitized debt at fair value for the years ended December 31, 2023 and 2022 ($ in thousands):
Securitized debt:
Interest expense
110,268
Average outstanding unpaid principal balance
Effective interest rate (1)
F-38
As of December 31, 2023, the Company is the sole beneficial interest holder of twenty-four Trusts, which are variable interest entities included in the consolidated financial statements. The 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, 2023 and 2022, and the stated maturity for each outstanding securitized debt (in thousands):
Securities Retained as of
Trusts
SecuritiesIssued
IssuanceDate
Stated MaturityDate
319,809
38,792
17,541
April 2046
245,601
12,927
2,416
2,697
October 2047
176,816
9,308
2,065
April 2048
307,988
16,210
3,614
4,352
October 2048
235,580
12,399
4,178
March 2049
207,020
10,901
4,007
July 2049
154,419
8,127
3,281
October 2049
248,700
13,159
6,746
February 2050
96,352
32,118
12,847
June 2050
251,301
13,227
10,120
May 2051
194,918
10,260
August 2051
204,205
October 2051
319,116
December 2051
273,594
5,015
4,206
4,718
February 2052
241,388
11,202
10,971
11,170
March 2052
84,967
40,911
45,026
44,038
May 2047
296,323
18,914
15,489
18,587
May 2052
308,357
25,190
13,414
25,027
July 2052
188,754
65,459
12,649
65,141
October 2052
198,715
41,593
4,043
December 2052
2023-1R Trust
64,833
66,228
October 2025
202,210
24,229
23,948
April 2053
81,608
4,296
July 2028
234,741
28,718
28,480
July 2053
202,890
26,623
26,482
November 2053
5,340,205
535,806
275,711
236,515
F-39
The following table summarizes outstanding bond balances for each securitized debt as of December 31, 2023 and 2022 (in thousands):
22,369
45,869
59,183
33,505
43,596
76,871
93,792
76,391
91,167
66,340
82,508
58,089
67,899
106,976
136,643
45,180
60,445
171,748
196,969
143,797
170,072
158,043
178,038
244,919
273,489
236,358
256,667
210,217
233,045
31,508
54,528
257,047
280,066
274,419
301,856
162,925
186,577
177,250
58,237
188,805
227,228
201,813
Total outstanding bond balance
2,788,909
F-40
Prior to 2023, the securities and certificates were typically issued at a discount to par, which was recorded as a contra liability to the securities issued. Securitized debt accounted for under the FVO accounting has no discounts or premiums. Discounts or premiums on securitized debt carried at amortized cost are amortized as an adjustment of yield over the stated term of the related securitized debt adjusted for prepayments. As of December 31, 2023 and 2022, unamortized discounts or premiums associated with the securities carried at amortized costs are as follows (in thousands):
(150
2021-Trust
127
162
474
642
2,622
3,546
2,784
189
4,552
6,161
4,878
727
967
Total unamortized discounts (premiums)
16,758
21,527
Other than securitized debt carried at fair value, professional and other capitalized issuance costs associated with the securitized debt are recorded as a contra liability to the securities issued. As of December 31, 2023 and 2022, capitalized issuance costs associated with the Trusts are as follows (in thousands):
392
535
185
303
627
908
432
687
597
866
471
675
1,351
115
369
1,392
1,978
1,347
1,924
1,563
2,178
2,382
3,177
2,252
3,045
2,188
877
2,721
3,679
2,498
3,303
1,760
2,349
595
Total capitalized issuance costs
22,870
31,092
F-41
As of December 31, 2023 and 2022, the weighted average rate on the sold securities and certificates for the Trusts are as follows:
9.07
8.59
3.97
3.92
4.03
4.05
4.48
4.46
4.07
4.06
3.42
3.46
3.29
3.25
2.85
4.61
4.60
1.76
1.73
2.02
2.44
3.22
3.20
3.93
5.07
6.90
6.91
5.70
5.67
6.24
6.23
7.06
7.10
7.02
7.68
7.19
8.24
7.82
8.38
F-42
Note 18 — 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 typically 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 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, 2023 and 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 $3.9 million and $5.2 million as of December 31, 2023 and 2022, respectively. The 2022 Term Loan is secured by substantially all assets of the Company not otherwise pledged under a securitized debt 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, 2023, 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 September 2022 Term Repurchase Agreement”). The Facility Agreement has a current extended maturity date of July 31, 2024, 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 were 6.2% and 5.6% for the years ended December 31, 2023 and 2022, respectively.
On August 8, 2016, Century entered a Promissory Note Revolving Credit Line with a bank (“Revolving Credit Line”). The Revolving Credit Line matured on July 31, 2023, and was a short-term unsecured borrowing line, with a maximum capacity of $3.0 million, and bore interest at SOFR plus 2.00% with a 0.25% floor. There were no outstanding balances as of December 31, 2023 and 2022.
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 26, 2024, 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 9.8% and 5.7%, for the years ended December 31, 2023 and 2022, 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 9.2% and 5.8% for the years ended December 31, 2023 and 2022, respectively.
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 May 15, 2024, and was a short-term borrowing facility, collateralized by a pool of loans, with a maximum capacity of $200.0 million, and bears interest at SOFR plus a margin of 3.00% during the availability period and 4.00% 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 10.0% and 6.4% for the years ended December 31, 2023 and 2022, respectively.
F-43
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, 2026, with a borrowing period through April 14, 2025. During the borrowing period, the Company can take loan advances from time to time subject to availability. Each loan advance bears interest at SOFR plus a margin of 3.10%. The maximum capacity under this facility is $100.0 million. The effective interest rates were 8.3% and 5.6% for the years ended December 31, 2023 and 2022, 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 American Interbank Offered Rate ("AMERIBOR") with a 0.5% floor plus 4.50% per annum. The maximum capacity under this facility is $100.0 million. The effective interest rates were 14.2% and 10.0% for the years ended December 31, 2023 and 2022, respectively.
On October 7, 2022, the Company entered into a $10.2 million short-term repurchase agreement ("the October 2022 Repurchase Agreement) that bore interest at SOFR plus 1.58%. The repurchase agreement was paid off in April 2023.
On October 12, 2023, the Company entered into a $9.5 million short-term repurchase agreement, and bore interest at 7.0%. On December 14, 2023, the Company entered into two $10.0 million short-term repurchase agreements, one agreement bore interest at 7.6%, and the other agreement bore interest at 7.5%.
On December 27, 2023, the Company entered into a loan facility agreement (“the 2023 Repurchase Agreement”) with a bank. The 2023 Repurchase Agreement has a maturity date of December 27, 2026. 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 3.00%. The maximum loan amount under this facility is $50.0 million. The effective interest rate was 8.6% for the year ended December 31, 2023.
Certain of the Company’s loans are pledged as security under the warehouse repurchase facilities and the revolving loan facility, which contain covenants. Should the Company fail to adhere to those covenants or otherwise default under the facilities, the lenders have the right to terminate the facilities and demand immediate repayment that may require the Company to sell the collateral at less than the carrying amounts. As of December 31, 2023 and 2022, the Company was in compliance with all covenants.
The following table summarizes the maximum borrowing capacity and current gross balances outstanding for the Company’s warehouse facilities and loan agreements as of December 31, 2023 and 2022 (in thousands):
Period endbalance (1)
Maximumborrowingcapacity
30,460
100,000
74,334
88,817
200,000
79,504
22,516
2,185
111,086
300,000
136,165
The bank credit agreement
31,950
50,000
29,495
The October 2022 repurchase agreement
29,522
30,530
10,057
18,818
22,000
The September 2022 term repurchase agreement
60,000
Revolving credit line
3,000
890,530
331,740
831,818
F-44
The following table provides an overview of the activity and effective interest rate for the years ended December 31, 2023, 2022, and 2021 ($ in thousands):
Warehouse and repurchase facilities:
Average outstanding balance
299,060
Highest outstanding balance at any month-end
426,959
336,775
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, 2023, 2022, and 2021 (in thousands):
Total interest expense
Note 19 — Income Taxes
The Company elected to be treated as a corporation, for tax purposes, effective January 1, 2018. The following table details the Company’s income tax expense (benefit) (in thousands):
Current tax expense (benefit):
Federal
13,631
(90
15,042
State
2,509
552
5,477
Total current tax expense
16,140
462
20,519
Deferred tax expense (benefit):
1,654
8,553
(7,362
1,040
3,018
(2,588
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, 2023, 2022, and 2021:
Federal income tax provision at statutory rate
21.0
State income taxes, net of federal tax benefit
6.2
5.6
Permanent items
0.1
Federal true-ups
Tax credits
(0.3
(0.2
Change in unrecognized tax benefit
(2.3
Other
(0.1
Effective tax rate
25.2
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-45
The tax effects of temporary differences that give rise to deferred tax assets and deferred tax liabilities as of December 31, 2023 and 2022 are presented below (in thousands):
Deferred tax assets:
Net operating loss
8,451
Mark-to-market on loans
355
Lease liability
780
783
Stock compensation
1,779
1,485
Accrued vacation
386
Intangibles
REO
Deferred state taxes
374
696
Research and experimental expenditures capitalization
1,721
MSR Valuation Allowance
53
Derivative - OCI
ERC Refund
1,038
Gross deferred tax assets
6,721
12,212
Deferred tax liabilities:
REMIC book-tax basis difference
(2,522
(4,941
(36
Right-of-use assets
(735
(717
Deferred origination costs
(63
(138
Property and equipment
(332
(595
(30
MSR valuation
(758
(694
Gross deferred tax liabilities
(4,382
(7,179
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 $5.7 million are utilized to offset current U.S. federal taxable income in 2023. State NOL carryforwards totaling $2.5 million are utilized to offset taxable income in 2023. There are no additional NOL carryforwards after 2023.
The Company had no valuation allowance as of December 31, 2023 and 2022. 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, 2023, the Company is no longer subject to U.S. tax examinations for years before 2020 and is no longer subject to state tax examinations for years before 2019.
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.
F-46
The Company had gross unrecognized tax benefits in the amount of $0.4 million and $1.9 million recorded as of December 31, 2023 and 2022, respectively. If recognized, $0.3 million of the unrecognized tax benefit would affect the 2023 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 $0.5 million, $0.1 million, and $0.1million as of December 31, 2023, 2022, and 2021, respectively. As of December 31, 2023 and 2022, the accrued interest and penalties related to unrecognized tax benefits were $32.9 thousand and $0.6 million, respectively.
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, 2023 and 2022, respectively (in thousands):
1,940
1,911
1,860
Changes related to current year tax positions
93
68
49
Changes related to prior year tax positions
Decreases due to lapsed statutes of limitations
(1,668
390
Note 20 — 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. On September 8, 2023, the Company granted stock options to an employee to purchase 5,464 shares of common stock with an exercise price per share equal to the grant date market price of $11.68. During the year ended December 31, 2023, 37,500 shares were exercised at the exercise price per share of $13.00. Cash received from option exercised for the year ended December 31, 2023 was $0.5 million. No stock options were exercised during the years ended December 31, 2022 and 2021.
The Company uses the Black-Scholes option pricing model to value stock options in determining the stock-based compensation expense. Forfeitures are recognized as they occur. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the date of grant. The expected dividend yield was zero as the Company is not expected to pay dividends in the foreseeable future. Expected volatility is based on the estimated average maximum volatility provided by a third-party investment bank due to the lack of historical volatilities of the Company’s common stock.
The following table presents the assumptions used in the option pricing model at the grant date for options granted during the year ended December 31, 2023:
Assumptions:
Expected volatility
28.00
Expected dividends
Risk-free interest rate
1.50
Expected forfeited rate
F-47
The tables below summarize stock option activity during the years ended December 31, 2023 and 2022:
($ 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
5,464
11.68
Exercised
(37,500
13.00
Forfeited
Options outstanding at end of year
752,964
12.88
6.1 years
3,269
Options exercisable at end of year
747,500
3,239
Options expected to vest (1)
9.7 years
7.1 years
523,333
261,667
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 5,464 and 261,667 shares as of December 31, 2023 and 2022, respectively, at a weighted average exercise price per share of $11.68 and $12.89, respectively. The amount of unrecognized compensation expense related to unvested stock options was $22.4 thousand, and the weighted average period over which it is expected to be recognized is 2.69 years as of December 31, 2023.
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.
In January 2023, the Company issued 198,137 shares of restricted stock awards to certain employees, including named executive officers, at no cost to employees. In May 2023, the Company issued 31,629 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 $3.7 million, and the weighted average period over which it is expected to be recognized is 1.73 years as of December 31, 2023.
F-48
The table below summarizes restricted stock award activity during the year ended December 31, 2023 and 2022:
Employee
Non-Employee Director
Restricted Stock Awards
Number of Shares
Weighted Average Grant Date Fair Value
Nonvested at December 31, 2022
445,250
8.61
48,889
9.72
494,139
8.72
198,137
10.00
9.01
9.86
Vested
(234,250
8.42
(19,242
9.87
(253,492
8.53
Nonvested at December 31, 2023
409,137
9.39
61,276
9.31
470,413
9.38
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
(160,000
(8,837
(168,837
In February 2022, the Company began granting performance stock units ("PSUs") 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. In February 2022, the Company granted 102,750 PSUs and in January 2023, the Company granted 153,637 PSUs. The granted PSUs represent 100% of the original target award amounts vesting eligibility is based on performance and service conditions of distinct three-year service periods for each award. Accordingly, the number of shares issued at the end of any performance period could range between 0% and 200% of the original target award amount.
F-49
A summary of the PSU activity for the years ended December 31, 2023, and 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
153,637
Outstanding at end of year, nonvested
256,387
11.05
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, 2023, a total of 241,132 shares have been issued under the ESPP with 167,123 shares issued in 2023 and 74,009 shares issued in 2022.
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:
5.45
2.50
Expected term (in years)
51.31
49.93
Dividend yield
Grant date fair value per share
11.78
11.31
The Company recognized a total of $3.9 million and $3.1 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, 2023 and 2022, 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 were $3.8 million and $3.6 million as of December 31, 2023 and 2022.
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 years ended December 31, 2023 and 2022, the Company purchased treasury shares of 87,765 and 33,647 at an average price of $9.81 per share and $13.61 per share, respectively.
Note 21 — Earnings 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.
F-50
The following table presents the basic and diluted income per share calculations for the years ended December 31, 2023, 2022, and 2021:
(In thousands, except per share data)
Basic EPS:
Less: earnings attributable to participating securities
Net earnings attributable to common shareholders
Basic earnings per common share
Diluted EPS:
Net income attributable to common shareholders
Add dilutive effects for assumed conversion of Series A preferred stock
8,989
Add dilutive effects for warrants
2,020
2,025
1,974
Add dilutive effects for stock options
Add dilutive effects of unvested restricted stock awards
173
188
203
Add dilutive effects of unvested performance-based stock units
71
Weighted average diluted common shares outstanding
Diluted earnings 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):
Stock options
773
Shares equivalents excluded from EPS
Note 22 — Warrants
On April 7, 2020, the Company issued and sold in a private placement warrants (the “Warrants”) to purchase additional shares of the Company’s common stock to funds affiliated with TruArc Partners (TruArc), formerly Snow Phipps, and a fund affiliated with Pacific Investment Management Company LLC (TOBI). TruArc and TOBI are considered affiliates and, therefore, are related parties to the Company. The awards were treated as equity awards at the date of issuance.
The Warrants are exercisable at the warrant holder’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 2,008,749 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 warrant holder together with its affiliates would beneficially own 49% or more of the Company’s outstanding common stock.
F-51
Note 23 — 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, 2023 and 2022, geographic and property type concentrations of loans, by unpaid principal balance, were as follows:
Geographic concentration:
22.0
22.8
19.9
13.3
Other states (individually less than 5.0%)
39.0
36.5
Property type concentration:
55.0
52.7
12.6
8.4
8.7
8.6
5.4
6.4
Other (individually less than 5.0%)
5.2
As of December 31, 2023 and 2022, the Company held $44.3 million and $13.3 million, respectively, of real estate owned, net, with geographic concentrations as follows:
Texas
25.9
14.1
17.0
16.1
Georgia
5.9
5.8
11.2
Massachusetts
4.8
21.3
Maryland
1.0
16.8
14.8
Note 24 — 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.
F-52
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, 2023 and 2022, the balance of repurchase liability was $66 thousand and $124 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.
Under the provisions of the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) signed into law on March 27, 2020 and the subsequent extension of the CARES Act, the Company, with the guidance from a third-party specialist, determined it was eligible for a refundable employee retention credit (“ERC”) subject to certain criteria.
The Company applied for ERC for the first three quarters’ wages paid in calendar year 2021. During the second quarter of 2023, the Company received approximately $4.2 million of ERC. Due to the subjectivity of the credit, the Company elected to account for the ERC as a gain analogizing to ASC 450-30, Gain Contingencies. Accordingly, the $4.2 million ERC, net of the third-party specialist fees of $0.6 million, are deferred until the uncertainty surrounding them is resolved. The net amount is included in accounts payable and accrued expenses on the consolidated balance sheets as of December 31, 2023.
Note 25 — 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, 2023, 2022, and 2021, the Company expensed $1.0 million, $794 thousand, and $579 thousand, respectively. These amounts are included in "compensation and employee benefits" on the consolidated statements of income.
Note 26 — Other Operating Expenses
The following table presents the components of other operating expenses for the years ended December 31, 2023, 2022 and 2021 (in thousands):
Travel, marketing and business development
872
661
Data processing and telecommunications
3,175
3,022
2,476
Office expenses
1,161
1,396
Insurance, taxes, and licenses (1)
1,851
2,300
2,420
1,446
1,262
971
Total other operating expenses
F-53
Note 27 — 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. The Company's related parties have not exercised any warrants as of December 31, 2023.
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. No loans were sold to any affiliate during the year ended December 31, 2023.
Note 28 — Fair Value Measurements
Fair Value Determination
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:
Transfers to/from Levels 1, 2 and 3 are recognized at the beginning of the reporting period in which a change in valuation technique or methodology occurs. 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 Cash Equivalents and Restricted Cash
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.
F-54
Loans Held for Investment, Net, and Loans Held for Investment, at Fair Value
The Company uses a third-party loan valuation model to estimate the fair value of its nonperforming mortgage loans, a Level 3 measurement. The significant unobservable inputs used in the fair value measurement of the Company’s nonperforming mortgage loans are interest rates, market yield requirements, the probability of default, loss given default, voluntary prepayment speed and loss timing. The Company uses an in-house loan valuation model to estimate the fair value of its performing mortgage loans, a Level 3 measurement. The significant unobservable inputs used in the fair value measurement of the Company’s performing mortgage loans are discount rate, constant prepayment rate, constant default rate, and loss severity rate. Significant changes in any of those inputs in isolation could result in a significant change to the mortgage loans’ fair value measurement.
Collateral Dependent or Loans Individually Evaluated
Nonaccrual loans held for investment are evaluated individually and are adjusted to the fair value of the collateral when the fair value of the collateral is below the carrying value of the loan. 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
Loans held for sale 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, at Fair Value
The Company has elected to account for certain loans originated with the intent to sell at fair value (the FVO Loans held for sale) using FASB ASC Topic 825, Financial Instruments (ASC 825). The FVO loans held for sale are measured based a discounted cash flow model, or 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.
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.
Derivative Instruments
Derivative financial instruments are measured at fair value using readily observable market inputs and the overall fair value measurement is classified as Level 2.
Secured Financing, Net (Corporate Debt)
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.
F-55
Warehouse Repurchase Facilities, Net
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.
Securitized Debt, Net and Securitized Debt, at Fair Value
Due to the fair value option accounting election on securitized debt in the first quarter of 2023, the Company changed the valuation technique to estimate the fair value of securitized debt. Prior to the first quarter of 2023, the fair value estimate of securitized debt was based on a third-party valuation model that calculate estimated cash flows discounted at an appropriate market rate, a Level 3 measurement. Starting the first quarter of 2023, the Company obtains the fair value estimates at instrument level from a third-party broker dealer based on trader input on benchmark securities, bond structure and collateral characteristics and performance and pricing factors such as yield, spread, average life, prepayment speeds, default rate and severity, a Level 2 measurement. Significant changes in any of those inputs in isolation could result in a significant change to securitized debt’s fair value measurement.
Accrued Interest Receivable and Accrued Interest Payable
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.
Receivables Due From Servicers
The carrying amounts of receivables due from servicers approximate fair value due to the short-term nature of these instruments, a Level 1 measurement.
Fair Value Disclosures
The following tables present information on assets measured and recorded at fair value as of December 31, 2023 and 2022, by level, in the fair value hierarchy (in thousands):
Fair value measurements using
Total at
Level 1
Level 2
Level 3
Assets:
Nonrecurring fair value measurements:
Individually evaluated loans requiring specific allowance, net
8,475
Total nonrecurring fair value measurements
52,743
Recurring fair value measurements:
Total recurring fair value measurements
1,314,650
1,332,240
1,367,393
1,376,508
Liabilities:
Derivative liabilities
881,082
F-56
24,791
285,333
310,124
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
Loans held for sale, net
Real estate held for sale, net
310
Total net loss
(3,781
(53
(480
The following tables present the primary valuation techniques and unobservable inputs related to Level 3 assets as of December 31, 2023 and 2022 ($ in thousands):
Asset category
Fair value
Primaryvaluationtechnique
Unobservableinput
Range
Weightedaverage
Nonrecurring:
Individually evaluated loans requiring allowance, net
Market comparables
Selling costs
8.0%
Recurring:
Discounted cash flow
Discount rate
9.3%
Prepayment rate
0.7% to 50.0%
5.8%
Default rate
0.0% to 1.7%
0.7%
Loss severity rate
0.0% to 14.8%
2.1%
5.3% to 16.0%
6.5%
F-57
8.35% to 9.35%
8.9%
1.0% to 30.0%
15.1%
0.12% to 6.99%
0.6%
0.0% to 18.45%
3.5%
8.0% to 12.0%
8.1%
5.6% to 16.8%
6.3%
The following is a roll-forward of loans held for investment that are measured at estimated fair value on a recurring basis for the years indicated (in thousands):
1,359
Originations
267,278
Loans liquidated
(73,623
(765
(163
Principal paydowns
(9,940
(261
(46
Total unrealized gain included in net income
47,214
7,436
Loans transferred to held for sale
(25,783
REO transfer
(777
Loans repurchased
1,048
The following is a roll-forward of loans held for sale that are measured at estimated fair value on a recurring basis for the years indicated (in thousands):
31,328
(46,843
(31,328
Loans transferred from held for investment
25,783
The following is a roll-forward of mortgage servicing rights that are measured at estimated fair value on a recurring basis for the years indicated (in thousands):
Total unrealized (loss) gain included in net income
F-58
The Company estimates the fair value of certain financial instruments on a quarterly basis. These instruments are recorded at fair value through the use of a valuation allowance only if they are individually evaluated. 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, 2023 and 2022, financial assets and liabilities measured at fair value include loans held for investment at fair value, loans held for sale at fair value, mortgage servicing rights, derivative instruments, and securitized debt at fair value. Financial assets measured at the lower of cost or estimated fair value include certain individually evaluated loans held for investment and REO, which were measured using unobservable inputs, including appraisals and broker price opinions on the values of the underlying collateral. Individually evaluated loans requiring an allowance were carried at approximately $8.5 million and $11.5 million as of December 31, 2023 and 2022, net of specific allowance for loan losses of approximately $1.0 million and $1.1 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. The estimated fair value of loans held for sale, at fair value; loans held for investment, at fair value; mortgage servicing rights; securitized debt, at fair value; are also presented in Notes 5, 6, 11, and 17, respectively.
Carrying
Estimated
Value
Cash
2,672,705
212,625
2,155,718
Accrued interest payable
20,473
F-59
3,201,850
Accrued interest receivable
211,854
Warehouse repurchase facilities, net
Securitizations, net
2,522,010
16,369
Note 29 — Select Quarterly Financial Data (Unaudited)
The following tables set forth the Company's unaudited quarterly results for the periods indicated:
Other operating income (1)
Operating expenses (1)
17,166
12,169
12,222
10,736
8,227
10,290
10,771
3,231
Less (loss) income attributable to noncontrolling interest
Note 30 — Subsequent Events
The Company completed the securitization of $221.1 million of investor real estate loans on January 16, 2024, which will be accounted for as secured borrowings during the quarter ending March 31, 2024.
The Company has evaluated events that have occurred subsequent to December 31, 2023, and has concluded there are no other subsequent events that would require recognition in the accompanying consolidated financial statements.
F-60
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 15, 2024
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
(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/ Omar Maasarani
Omar Maasarani