UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 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 Number: 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. EmployerIdentification 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(s)
Name of each exchange on which registered
Common stock, par value $0.01 per share
VEL
The New York Stock Exchange
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, 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 check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
As of August 1, 2023, the registrant had 32,764,110 shares of common stock outstanding.
Table of Contents
Page
PART I.
FINANCIAL INFORMATION
Item 1.
Consolidated Financial Statements (Unaudited)
2
Consolidated Balance Sheets
Consolidated Statements of Income
4
Consolidated Statements of Changes in Stockholders’ Equity
5
Consolidated Statements of Cash Flows
6
Notes to Consolidated Financial Statements (Unaudited)
8
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
30
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
50
Item 4.
Controls and Procedures
PART II.
OTHER INFORMATION
Legal Proceedings
51
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
52
SIGNATURES
54
i
PART I—FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited)
VELOCITY FINANCIAL, INC.
CONSOLIDATED BALANCE SHEETS
($ in thousands, except par value amounts)
June 30, 2023
December 31, 2022
(Unaudited)
ASSETS
Cash and cash equivalents
$
33,987
45,248
Restricted cash
16,786
16,808
Loans held for investment, net
3,057,940
3,272,390
Loans held for investment, at fair value
705,330
276,095
Total loans, net
3,763,270
3,548,485
Accrued interest receivables
22,602
20,463
Receivables due from servicers
63,896
65,644
Other receivables
1,306
1,075
Real estate owned, net
20,388
13,325
Property and equipment, net
3,023
3,356
Deferred tax asset
1,878
5,033
Mortgage servicing rights, at fair value
9,445
9,238
Goodwill
6,775
Other assets
7,789
13,525
Total assets
3,951,145
3,748,975
LIABILITIES
Accounts payable and accrued expenses
95,344
91,525
Secured financing, net
210,464
209,846
Securitized debt, net
2,622,547
2,736,290
Securitized debt, at fair value
381,799
—
Warehouse and repurchase facilities, net
235,749
330,814
Total liabilities
3,545,903
3,368,475
Commitments and contingencies
EQUITY
Common stock ($0.01 par value, 100,000,000 shares authorized; 32,860,849 and 32,523,516 shares issued, 32,741,628 and 32,489,869 shares outstanding at June 30, 2023 and December 31, 2022, respectively)
329
326
Treasury stock, at cost (119,221 and 33,647 common shares at June 30, 2023 and December 31, 2022, respectively)
(1,294
)
(458
Additional paid-in capital
303,207
300,310
Retained earnings
99,465
76,633
Total Velocity Financial, Inc. stockholders' equity
401,707
376,811
Noncontrolling interest in subsidiary
3,535
3,689
Total equity
405,242
380,500
Total liabilities and equity
See accompanying Notes to Consolidated Financial Statements.
CONSOLIDATED BALANCE SHEETS (CONTINUED)
($ in thousands)
The following table represents the assets and liabilities of consolidated variable interest entities as follows:
2,980
2,968
3,384,981
3,108,316
Accrued interest and other receivables
81,272
77,191
17,443
10,380
13
15
3,486,689
3,198,870
55,507
50,169
Securitized debt
3,004,346
3,059,853
2,786,459
3
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
Three Months Ended June 30,
Six Months Ended June 30,
2023
2022
Interest income
74,897
59,243
145,418
111,292
Interest expense — portfolio related
45,451
28,752
87,480
52,308
Net interest income — portfolio related
29,446
30,491
57,938
58,984
Interest expense — corporate debt
4,139
4,182
8,278
21,322
Net interest income
25,307
26,309
49,660
37,662
Provision for loan losses
298
279
933
1,009
Net interest income after provision for loan losses
25,009
26,030
48,727
36,653
Other operating income
Gain on disposition of loans
1,237
1,776
3,149
6,317
Unrealized gain on fair value loans
2,413
9,767
16
Unrealized gain on fair value securitized debt
5,560
5,391
Origination income
2,735
554
5,145
1,187
Bank interest income
1,189
2,136
Other income
903
1,256
1,290
2,353
Total other operating income
14,037
3,592
26,878
9,873
Operating expenses
Compensation and employee benefits
10,670
6,553
20,678
11,876
Origination expenses
123
1,504
72
2,447
Securitization expenses
2,699
5,284
Loan servicing
4,267
3,290
8,095
5,741
Professional fees
1,056
1,062
2,011
2,423
Rent and occupancy
458
426
905
868
1,018
(251
2,846
(426
Other operating expenses
1,931
2,248
4,133
4,786
Total operating expenses
22,222
14,832
44,024
27,715
Income before income taxes
16,824
14,790
31,581
18,811
Income tax expense
4,602
4,019
8,623
4,809
Net income
12,222
10,771
22,958
14,002
Net income attributable to noncontrolling interest
39
126
236
Net income attributable to Velocity Financial, Inc.
12,183
10,645
22,832
13,766
Less undistributed earnings attributable to unvested restricted stock awards
185
164
347
212
Net earnings attributable to common stockholders
11,998
10,481
22,485
13,554
Earnings per common share
Basic
0.37
0.33
0.70
0.42
Diluted
0.36
0.31
0.67
0.40
Weighted average common shares outstanding
32,122
31,917
32,111
31,904
34,140
34,057
34,095
34,130
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
Common Stock
Treasury Stock
Shares
Par Value
AdditionalPaid-inCapital
RetainedEarnings
Amount
TotalStockholders'Equity
Noncontrolling Interest
Total Equity
Balance – December 31, 2021
32,293,042
323
296,364
44,422
341,109
3,381
344,490
Purchase of treasury stock, at cost
(33,647
Restricted stock awarded and earned stock compensation
125,250
416
418
Stock-based compensation - Options
251
3,121
110
3,231
Balance – March 31, 2022
32,418,292
325
297,031
47,543
344,441
3,491
347,932
31,215
555
254
Balance – June 30, 2022
32,449,507
297,840
58,188
355,895
3,617
359,512
Balance – December 31, 2022
32,523,516
(85,574
(836
Restricted stock awarded and stock-based compensation expenses
198,137
998
1,000
Distribution to non-controlling interest
(160
10,649
87
10,736
Balance – March 31, 2023
32,721,653
328
301,308
87,282
(119,221
387,624
3,616
391,240
Issuance of common stocks
107,567
1
874
875
31,629
1,025
(120
Balance – June 30, 2023
32,860,849
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
381
401
Amortization of right-of-use assets
642
664
(Reversal of) provision for repurchase of loans
(76
235
Origination of loans held for sale
(19,088
Proceeds from sales of loans held for sale
19,816
Net accretion of discount on purchased loans and amortization of deferred loan origination costs
2,446
3,981
Provision for (reversal of) uncollectible borrower advances
505
(14
(902
(4,809
Real estate acquired through foreclosure in excess of recorded investment
(2,248
(1,508
Amortization of debt issuance discount and costs
10,614
16,956
Loss on disposal of property and equipment
14
Change in valuation of real estate owned
1,670
(93
Change in valuation of fair value loans
(10,494
(16
Change in valuation of mortgage servicing rights
(207
(1,286
Change in valuation of fair value securitized debt
(5,391
Loss (gain) on sale of real estate owned
(1,620
Stock-based compensation
2,026
1,479
Deferred tax expense
3,154
1,408
Change in operating assets and liabilities:
(3,247
(1,680
5,094
(4,882
3,804
(11,141
Net cash provided by operating activities
32,429
13,100
Cash flows from investing activities:
Purchase of loans held for investment
(8,546
(5,021
Origination of loans held for investment
(456,534
(1,033,277
Proceeds from sales of loans originally classified as held for investment
21,489
224,060
Payoffs of loans held for investment and loans at fair value
221,423
302,098
Purchase of real estate owned
(2,250
Proceeds from sale of real estate owned
9,411
9,294
Change in advances
858
1,338
Change in impounds and deposits
(662
(3,904
Purchase of property and equipment
(48
(217
Net cash used in investing activities
(212,609
(507,879
Cash flows from financing activities:
Warehouse repurchase facilities advances
463,038
951,071
Warehouse repurchase facilities repayments
(557,753
(1,043,666
Proceeds from secured financing
215,000
Repayment of secured financing
(170,844
Proceeds of securitized debt, net
461,684
879,136
Repayment of securitized debt
(196,457
(308,298
Debt issuance costs
(1,373
(19,299
Proceeds from issuance of common stocks, net
Purchase of treasury stock
(837
(280
Net cash provided by financing activities
168,897
502,642
Net (decrease) increase in cash, cash equivalents, and restricted cash
(11,283
7,863
Cash, cash equivalents, and restricted cash at beginning of period
62,056
47,604
Cash, cash equivalents, and restricted cash at end of period
50,773
55,467
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Supplemental cash flow information:
Cash paid during the period for interest
83,445
49,779
Cash (received) paid during the period for income taxes, net
(844
21,579
Noncash transactions from investing and financing activities:
Transfer of loans held for investment to held for sale
25,075
206,319
Transfer of loans held for investment to real estate owned
15,935
5,485
Transfer of accrued interest to loans held for investment
878
816
Discount on issuance of securitized debt
17,136
Transfer of loans held for sale to held for investment
4,218
73,598
Recognition of new leases in exchange for lease obligations
656
See accompanying Notes to Consolidated Financial Statements
7
VELOCITY FINANCIAL, INC. AND SUBSIDIARIES
Note 1 — Organization and Description of Business
Velocity Financial, LLC (VF or the Company) was a Delaware limited liability company 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, 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 residential and commercial 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 primarily on the difference between the yield on its investor real estate loan portfolio and the cost of its borrowings. The Company may also sell loans from time to time. The Company does not originate or acquire investments outside of the United States of America.
The Company, through its wholly owned subsidiaries, is the sole beneficial owner of the Velocity Commercial Capital Loan Trusts, from the 2016-1 Trust through and including the 2023-2 Trust, all of which are New York common law trusts, with the exception of the VCC 2022-MC1 Trust which is a Delaware statutory trust. The Trusts are bankruptcy remote, variable interest entities (VIE) formed for the purpose of providing secured borrowings to the Company and are consolidated with the accounts of the Company.
On December 28, 2021, the Company acquired an 80% ownership interest in Century Health & Housing Capital, LLC (“Century”). Century is a licensed “Ginnie Mae” issuer/servicer that provides government-insured Federal Housing Administration (FHA) mortgage financing for multifamily housing, senior housing and long-term care/assisted living facilities. Century originates loans through its borrower-direct origination channel and services the loans through its in-house servicing platform, which enables the formation of long-term relationships with its clients and drives strong portfolio retention. Century is a consolidated subsidiary of the Company as of completion of the acquisition. In addition, as a servicer of Ginnie Mae loans, Century is required to maintain a minimum net worth, and Century is in compliance with this requirement as of June 30, 2023.
Note 2 — Basis of Presentation and Summary of Significant Accounting Policies
The accompanying unaudited Consolidated Financial Statements as of and for the three and six months ended June 30, 2023 and 2022 have been prepared on a basis that is substantially consistent with the accounting principles applied to the Company’s audited Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022.
The information furnished in these interim statements reflects all adjustments that are, in the opinion of management, necessary for a fair statement of the results for each respective period presented. Such adjustments are of a normal, recurring nature. The results of operations in the interim statements are not necessarily indicative of the results that may be expected for any other quarter for the full year. The interim financial information should be read in conjunction with the Company’s audited Consolidated Financial Statements.
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.
The Company’s significant accounting policies are described in Note 2 — Basis of Presentation and Summary of Significant Accounting Policies, of its audited consolidated financial statements included in its Annual Report on Form 10-K for the year ended December 31, 2022 as filed with the Securities and Exchange Commission.
There have been no significant changes to the Company’s significant accounting policies as described in its 2022 Annual Report, other than the election of fair value option accounting on securitized debt issued effective January 1, 2023.
Certain amounts previously reported have been reclassified to conform to the current presentation.
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 June 30, 2023 and December 31, 2022 include only those assets, liabilities, and results of operations related to the business of the Company, its subsidiaries, and VIEs.
The Company has elected to apply fair value option ("FVO") accounting to securitized debt issued effective January 1, 2023 when the underlying collateral is also carried at fair value. The fair value option 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” in the consolidated statements of income and presents the other fair value changes of these securitized debt separately in the consolidated financial statements.
Note 3 — Current Accounting Developments
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 Company adopted ASU 2022-02 effective January 1, 2023 on a prospective basis. The adoption of ASU 2022-02 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 potential future advances due to 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 $83.5 million at June 30, 2023. This amount is not reflected on the consolidated balance sheet of the Company at June 30, 2023.
The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the Company’s consolidated balance sheets to the total of the same such amounts shown in the consolidated statements of cash flows for the six months ended June 30, 2023 and 2022 (in thousands):
46,250
9,217
Total cash, cash equivalents, and restricted cash shown in the statement of cash flows
9
Note 5 — Loans Held for Investment and Loans Held for Investment at Fair Value
The following tables summarize loans held for investment as of June 30, 2023 and December 31, 2022 (in thousands):
Total loans held for investment
Unpaid principal balance
3,031,725
688,100
3,719,825
Valuation adjustments on FVO loans
17,230
Deferred loan origination costs
30,841
3,062,566
3,767,896
Allowance for loan losses
(4,626
Total loans held for investment and loans held for investment at fair value, net
3,243,854
268,632
3,512,486
7,463
33,429
3,277,283
3,553,378
(4,893
The following tables summarize the Unpaid Principal Balance (“UPB”) and amortized cost basis of loans in the Company's COVID-19 forbearance program for the three and six months ended June 30, 2023 and the year ended December 31, 2022 ($ in thousands):
Three Months Ended June 30, 2023
Six Months Ended June 30, 2023
UPB
%
Amortized Cost
Beginning balance
195,114
197,350
201,005
203,346
Foreclosures
(99
Repayments
(13,175
(13,343
(18,967
(19,240
Ending balance
181,939
184,007
Performing/Accruing
138,419
76.1%
139,941
Nonperforming/Nonaccrual
43,520
23.9%
44,066
292,429
295,990
Additions
(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 $410.5 million in UPB of loans, which includes capitalized interest of $12.3 million. As of June 30, 2023, $234.7 million in UPB of modified loans has been paid down, which includes $4.7 million of capitalized interest received. The Company has not forgiven any capitalized interest.
10
Approximately 76.1% and 80.3% of the COVID forbearance loans in UPB were performing, and 23.9% and 19.7% were on nonaccrual status as of June 30, 2023 and December 31, 2022, respectively.
As of June 30, 2023 and December 31, 2022, the gross unpaid principal balances of loans held for investment pledged as collateral for the Company’s warehouse facilities and securitized debt issued were as follows (in thousands):
The 2013 repurchase agreement
86,225
170,185
The 2021 repurchase agreement
69,728
101,024
The Bank credit agreement
42,317
39,087
The 2021 term repurchase agreement
108,840
104,594
The July 2021 term repurchase agreement
14,878
3,859
Total pledged loans
321,988
418,749
2016-1 Trust
35,195
39,720
2017-2 Trust
57,059
67,048
2018-1 Trust
41,983
48,139
2018-2 Trust
94,530
104,791
2019-1 Trust
94,839
104,249
2019-2 Trust
82,180
91,025
2019-3 Trust
70,193
75,618
2020-1 Trust
129,485
144,913
2020-2 Trust
75,123
81,259
2021-1 Trust
208,875
2021-2 Trust
160,867
172,144
2021-3 Trust
168,487
178,861
2021-4 Trust
264,406
275,741
2022-1 Trust
253,457
262,526
2022-2 Trust
237,924
245,339
2022-MC1 Trust
81,071
97,246
2022-3 Trust
287,694
299,638
2022-4 Trust
316,472
326,627
2022-5 Trust
242,400
251,288
2023-1 Trust
232,332
2023-2 Trust
222,551
Total
3,343,362
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 June 30, 2023 and December 31, 2022. There were no loans accruing interest that were greater than 90 days past due as of June 30, 2023 and December 31, 2022.
Total Nonaccrual
Nonaccrual with No Allowance for Loan Loss
Nonaccrual with Allowance for Loan Loss
Allowance for Loans Individually Evaluated
% of Allowance to Total Nonaccrual Loans with Allowance
Commercial - Purchase
21,239
20,304
935
137
1.0
Commercial - Refinance
93,176
86,467
6,709
552
3.9
Residential 1-4 Unit - Purchase
49,826
Residential 1-4 Unit - Refinance
139,356
134,942
4,414
246
1.7
Short Term 1-4 Unit - Purchase
3,587
Short Term 1-4 Unit - Refinance
47,603
45,521
2,082
108
0.8
354,787
340,647
14,140
1,043
7.4
11
22,571
22,437
134
28
0.2
87,133
82,330
4,803
517
4.1
27,984
27,516
468
118
0.9
113,909
111,742
2,167
175
1.4
8,140
35,602
30,612
4,990
258
2.1
295,339
282,777
12,562
1,096
8.7
Troubled Debt Restructuring included in nonaccrual loans:
25
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.
The Company will continue 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 tables present the amortized cost basis in the loans held for investment, excluding loans held for investment at fair value, as of June 30, 2023 and 2022, and the amount of accrued interest receivables written off by reversing interest income by portfolio segment for the three and six months ended June 30, 2023 and 2022 (in thousands):
Interest Reversal
664,482
136
677,491
77
854,048
667
912,774
335
553,269
476
529,796
61
882,020
881
887,720
269
49,242
57,973
59,505
57,950
132
2,514
3,123,704
268
192
1,183
587
773
281
1,597
566
31
443
371
4,295
2,022
The cash basis interest income recognized on nonaccrual loans was $8.0 million and $8.7 million for the three months ended June 30, 2023 and 2022, respectively. No accrued interest income was recognized on nonaccrual loans for the six months ended June 30, 2023. The average recorded investment of individually evaluated loans, computed using month-end balances, was $331.4 million and $260.8 million for the three months ended June 30, 2023 and 2022, and $316.9 million and $271.3 million for the six months ended June 30, 2023 and 2022, respectively. There were no commitments to lend additional funds to debtors whose loans have been modified in troubled debt restructuring as of June 30, 2023 and 2022.
12
The following tables present the activity in the allowance for credit losses for the three and six months ended June 30, 2023 and 2022 (in thousands):
Residential
Short Term
Commercial
1-4 Unit
Purchase
Refinance
Allowance for credit losses:
Beginning Balance - April 1, 2023
796
2,060
1,363
24
334
5,045
(64
(34
(65
752
(192
Charge-offs
(717
732
403
1,264
59
142
4,626
Allowance related to:
Loans individually evaluated
Loans collectively evaluated
595
1,474
34
3,583
Amortized cost related to:
643,243
760,872
503,443
742,664
45,655
11,902
2,707,779
Three Months Ended June 30, 2022
Beginning Balance - April 1, 2022
518
2,140
389
1,029
537
4,663
94
(125
241
(19
(18
(37
612
1,996
440
1,270
553
4,905
434
196
1,164
606
1,562
388
1,074
3,741
14,911
80,442
22,885
96,649
2,302
38,013
255,202
662,580
832,332
506,911
791,071
55,671
19,937
2,868,502
Beginning Balance - January 1, 2023
639
2,031
542
1,272
21
4,893
93
74
(112
(79
(27
(11
(778
(305
(1,200
Six Months Ended June 30, 2022
Beginning Balance - January 1, 2022
385
2,144
400
948
43
342
4,262
374
(123
40
427
(9
300
(147
(25
(105
(89
(366
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 a credit quality indicator. Nonperforming loans are loans that are 90 or more days past due, in bankruptcy, in foreclosure, or not accruing interest. Past due status is based on the contractual terms of the loan. The annualized charge-off rates were 0.77% and 0.27% of average nonperforming loans for the six months ended June 30, 2023 and 2022, respectively.
Other credit quality indicators include aging status and accrual status. The following table presents the aging status of the amortized cost basis in the loans held for investment portfolio, which include $184.0 million and $203.3 million loans in the Company’s COVID-19 forbearance program, excluding loans held for investment at fair value, as of June 30, 2023 and December 31, 2022, respectively (in thousands):
30–59 days
60–89 days
90+days
past due
past due(1)
Current
loans
961
2,658
17,620
4,647
7,047
81,482
1,869
47,301
2,077
1,653
135,626
176
3,411
205
47,398
Total loans individually evaluated
8,517
13,432
332,838
28,861
7,744
36,605
606,638
38,895
17,841
56,736
704,136
24,371
7,171
31,542
471,901
40,966
21,836
62,802
679,862
823
3,336
4,159
41,496
1,082
745
1,827
10,075
Total loans collectively evaluated
134,998
58,673
193,671
2,514,108
143,515
72,105
548,458
865
21,706
4,415
5,943
76,619
86,977
156
590
592
26,802
1,715
2,728
109,466
7,964
657
34,945
8,418
9,263
277,502
295,183
24,899
5,096
29,995
648,842
678,837
41,711
20,561
62,272
757,692
819,964
22,840
13,948
36,788
523,661
560,449
64,925
23,224
88,149
737,247
825,396
21,273
294
21,567
40,177
61,744
5,550
1,191
6,741
28,814
35,555
181,198
64,314
245,512
2,736,433
2,981,945
189,616
73,577
540,695
2,736,589
3,277,284
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 June 30, 2023 and December 31, 2022 (in thousands).
Term Loans Amortized Cost Basis by Origination Year
June 30, 2023:
2021
2020
2019
Pre-2019
Payment performance
Performing
263,561
236,653
33,956
51,053
58,020
Nonperforming
4,536
4,956
533
4,166
7,048
Total Commercial - Purchase
268,097
241,609
34,489
55,219
65,068
246,580
199,498
52,015
92,882
169,897
22,102
13,323
5,139
21,205
31,407
Total Commercial - Refinance
268,682
212,821
57,154
114,087
201,304
224,109
205,756
9,145
27,854
36,579
19,331
20,310
1,969
2,147
6,069
Total Residential 1-4 Unit - Purchase
243,440
226,066
11,114
30,001
42,648
304,498
260,317
20,897
72,047
84,905
40,691
33,740
8,632
28,998
27,295
345,189
294,057
29,529
101,045
112,200
23,733
710
16,857
4,355
2,412
995
180
Total Short Term 1-4 Unit - Purchase
26,145
17,852
4,535
17,886
1,023
9,210
14,974
4,510
Total Short Term 1-4 Unit - Refinance
29,788
Total Portfolio
1,181,341
976,286
159,348
319,861
425,730
Gross charge-offs - quarter-ended June 30, 2023
717
Gross charge-offs - year-to-date June 30, 2023
743
446
1,200
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
701,408
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
907,097
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
588,433
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
939,305
40,967
944
15,659
4,174
1,287
5,212
104
42,254
6,156
16,654
4,716
69,884
786
1,221
10,545
18,245
4,805
36,341
71,157
1,243,841
1,033,695
168,977
358,100
231,024
241,647
17
The following table presents the aggregate fair value of loans held for investment and held 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 June 30, 2023 by loan segments (in thousands):
Fair Value
Unpaid Principal Balance
Difference
Current–89 days
90+days past due
or nonaccrual
100,143
462
100,605
94,622
95,214
(130
111,599
1,276
112,875
104,676
1,429
106,105
(153
156,032
3,224
159,256
154,132
158,265
(909
265,388
9,300
274,688
257,677
11,631
269,308
(2,331
26,701
1,012
27,713
27,072
1,298
28,370
(286
29,530
663
30,193
29,988
850
30,838
(187
689,393
15,937
668,167
19,933
(3,996
Note 6 — Receivables Due From Servicers
The following tables summarize receivables due from servicers as of June 30, 2023 and December 31, 2022 (in thousands):
Warehouse and repurchase facilities and other
Loan principal payments due from servicers
25,996
455
26,451
Other loan servicing receivables
11,518
2,326
13,844
Loan servicing receivables
37,514
2,781
40,295
Corporate and escrow advances receivable
23,220
23,601
Total receivables due from servicers
60,734
3,162
24,400
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 7 — Mortgage Servicing Rights
Mortgage loans serviced are related to the Century business and not included in the consolidated balance sheets. The unpaid principal balance of mortgage loans serviced for others amounted to $500.7 million and $491.9 million as of June 30, 2023 and December 31, 2022, respectively. The Company has elected to record its mortgage servicing rights using the fair value measurement method. Significant assumptions used in determining the fair value of servicing rights as of June 30, 2023 and December 31, 2022 include: 1) Weighted average discount rate of 8.0% and 8.1%. 2) Weighted average conditional prepayment rate of 6.9% and 6.3%.
The following table presents the Company's mortgage servicing rights as of June 30, 2023 and December 31, 2022 (in thousands):
Balance at the beginning of year
7,152
Mortgage servicing rights acquired, at fair value
250
Fair value adjustments
(43
2,086
Balance at end of period
18
Note 8 — Goodwill
The following table presents the activity for goodwill as of June 30, 2023 and December 31, 2022 (in thousands):
Balance at the beginning of period
Goodwill acquired
Note 9 — Securitized Debt and Securitized Debt at Fair Value
As of June 30, 2023, the Company is the sole beneficial interest holder of twenty-two Trusts, which are variable interest entities included in the consolidated financial statements. The securitization transactions are accounted for as secured borrowings under U.S. GAAP. The securities are subject to redemption by the Company when the stated principal balance is less than a certain percentage, ranging from 10%–30% of the original stated principal balance of loans at issuance. As a result, the actual maturity dates of the securities issued could be earlier than their respective stated maturity dates, ranging from July 2045 through April 2053.
The following tables summarize securitized debt and securitized debt at fair value as of June 30, 2023 and December 31, 2022 ($ in thousands):
(in thousands)
Securitized debt at fair value
Total securitized debt
2,668,582
389,628
3,058,210
Valuation adjustments on FVO securitized debt
(7,829
Deferred issuance costs and discounts
(46,035
Total securitized debt and securitized debt at fair value
2,788,908
(52,618
The following table presents the effective interest rate of securitized debt and securitized debt at fair value for the six months ended June 30, 2023 and 2022 ($ in thousands):
Securitized debt:
Interest expense
76,737
44,428
Average outstanding unpaid principal balance
2,973,388
2,175,263
Effective interest rate (1)
5.16
4.08
Note 10 — Other Debt
Secured financings 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. Most of these lines of credit fund less than 100% of the principal balance of the mortgage loans originated and purchased, requiring the use of working capital to fund the remaining portion.
19
On March 15, 2022, the Company entered into a five-year $215.0 million syndicated corporate debt agreement, the (“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 a term loan previously entered into during 2021 (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 June 30, 2023, 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 $4.5 million as of June 30, 2023. 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 June 30, 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 was 7.2% at June 30, 2023. There was no outstanding balance at December 31, 2022.
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 bears interest at SOFR plus 2.00% with a 0.25% floor. There were no outstanding balances at June 30, 2023 and December 31, 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 29, 2023, and is a short-term borrowing facility, collateralized by a pool of performing loans, with a maximum capacity of $300.0 million, and bears interest at SOFR plus 3.50%. All borrower payments on loans financed under the warehouse repurchase facility are first used to pay interest on the facility. The effective interest rates were 10.1% and 5.7% at June 30, 2023 and December 31, 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 capacity under this facility is $50.0 million. The effective interest rates were 8.9% and 5.8% at June 30, 2023 and December 31, 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 is 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 10.4% and 6.4% at June 30, 2023 and December 31, 2022, respectively.
On April 16, 2021, the Company entered into a non-mark-to-market Term Repurchase Agreement (“the 2021 Term Repurchase Agreement”) with a warehouse lender. The 2021 Term Repurchase Agreement has a maturity date of April 16, 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% at June 30, 2023 and December 31, 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 21.1% and 10.0% at June 30, 2023 and December 31, 2022, respectively.
On October 7, 2022, the Company entered into a $10.2 million short-term repurchase agreement ("the October 2022 Repurchase Agreement) and bore interest at SOFR plus 1.58%. The repurchase agreement was paid off in April 2023. The effective interest rates were 6.6% and 6.1% at June 30, 2023 and December 31, 2022, respectively.
20
Certain loans are pledged as security under the warehouse repurchase facilities and the revolving loan facility, which contain covenants. Should the Company fail to adhere to those covenants or otherwise default under the facilities, the lenders have the right to terminate the facilities and demand immediate repayment that may require the Company to sell the collateral at less than the carrying amounts. As of June 30, 2023 and December 31, 2022, the Company was in compliance with all covenants.
The following table summarizes the maximum borrowing capacity and current gross balances outstanding of the Company’s warehouse facilities and loan agreements as of June 30, 2023 and December 31, 2022 (in thousands):
Period endbalance (1)
Maximumborrowingcapacity
73,097
100,000
74,334
54,482
200,000
79,504
8,534
2,185
69,436
300,000
136,165
The bank credit agreement
31,476
50,000
29,495
The October 2022 repurchase agreement
10,057
18,818
The September 2022 term repurchase agreement
60,000
Revolving credit line
3,000
237,025
813,000
331,740
831,818
The following table provides an overview of the activity and effective interest rate for the three and six months ended June 30, 2023 and 2022 ($ in thousands):
Warehouse and repurchase facilities:
Average outstanding balance
238,027
318,960
231,762
328,603
Highest outstanding balance at any month-end
320,544
379,169
426,959
9.93
9.27
4.80
The following table provides a summary of interest expense that includes interest, amortization of discount, and deal cost amortization for the three and six months ended June 30, 2023 and 2022 (in thousands):
Warehouse and repurchase facilities
5,910
4,115
10,743
7,880
39,541
24,637
Total interest expense
49,590
32,934
95,758
73,630
Note 11 — Commitments and Contingencies
When the Company sells loans, it is required to make normal and customary representations and warranties about the loans to the purchaser. The loan sale agreements generally require the Company to repurchase loans if the Company breaches a representation or warranty given to the loan purchaser. In addition, the Company may be required to repurchase loans as a result of borrower fraud or if a payment default occurs on a loan shortly after its sale.
The Company records a repurchase liability relating to representations and warranties and early payment defaults. The method used to estimate the liability for repurchase is a function of the representations and warranties given and considers a combination of factors, including, but not limited to, estimated future defaults and loan repurchase rates and the potential severity of loss in the event of defaults. The Company establishes a liability at the time loans are sold and continually updates the estimated repurchase liability. The level of the repurchase liability for representations and warranties and early payment default requires considerable management judgment. As of June 30, 2023 and December 31, 2022, the balance of repurchase liability was $48 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 for the quarter ended June 30, 2023.
Note 12 — 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.
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 and 102,750 shares of performance stock unit 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 and 153,637 shares of performance stock unit 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.
Restricted stock-based awards vest ratably over a service period of three years from the date of the grant. Performance-based stock unit awards are linked to the average core net income annual growth over the three-year period from the year of grant. Settlement of vested performance-based stock units will be made on the date that the Compensation Committee certifies the average core net income annual growth for the three-year period. Compensation expense related to restricted stock-based awards 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. Compensation expense related to performance-based stock unit awards is based on the fair value of the underlying stock on the award date and is recognized over the vesting period using an estimate of the probability of achieving the performance target. The estimates will be reviewed quarterly, and the expense adjusted accordingly.
The Company has an Employee Stock Purchase Plan ("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 beginning July 2022. 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. Compensation expense 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 Company recognized a total of $1.0 million and $0.8 million compensation expense related to the outstanding stock options, unvested restricted stock awards, ESPP, and unvested performance-based stock unit awards granted to employees for the three months ended June 30, 2023 and 2022, respectively. Such amount is included in “Compensation and employee benefits” on the Consolidated Statement of Income. The amount of unrecognized compensation expense related to unvested restricted stock awards, ESPP, and performance-based stock unit awards totaled $5.7 million and $5.3 million as of June 30, 2023 and 2022, respectively.
Treasury share purchases represent shares surrendered to the Company approximately equal in value to the statutory payroll tax withholding obligations and other estimated tax obligations arising from the vesting of employee restricted stock awards. During the
22
three months ended March 31, 2023, the Company purchased 85,574 treasury shares at an average price of $9.78 per share. No shares were purchased during the three months ended June 30, 2023.
Note 13 — 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.
The following table presents the basic and diluted earnings per share calculations for the three and six months ended June 30, 2023 and 2022:
(In thousands, except per share data)
Basic EPS:
Net income attributable to common shareholders
Less: earnings attributable to participating securities
Net earnings attributable to common shareholders
Basic earnings per common share
Diluted EPS:
Net income attributable to common stockholders
Add dilutive effects for warrants
1,883
1,986
1,877
2,057
Add dilutive effects for stock options
Add dilutive effects of unvested restricted stock awards
95
150
78
165
Add dilutive effects of unvested performance-based stock units
36
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
Unvested restricted stock awards
84
125
Unvested performance-based stock units
103
Share equivalents excluded from EPS
857
1,001
Note 14 — 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 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.
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.
23
Note 15 — 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:
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.
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 yield, voluntary prepayments, severity, and foreclosure frequency. 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, and constant default 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 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 to Ginnie Mae 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 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 (REO)
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.
Mortgage Servicing Rights
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.
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.
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
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 severities, 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 and liabilities measured and recorded at fair value as of June 30, 2023 and December 31, 2022, by level, in the fair value hierarchy (in thousands):
Fair value measurements using
Total at
Level 1
Level 2
Level 3
fair value
Assets:
Recurring fair value measurements:
Mortgage servicing rights
Total recurring fair value measurements
714,775
Nonrecurring fair value measurements:
Individually evaluated loans requiring specific allowance, net
13,097
Total nonrecurring fair value measurements
33,485
748,260
Liabilities:
285,333
11,466
24,791
310,124
The following table presents gains and losses recognized on assets measured on a nonrecurring basis for the three and six months ended June 30, 2023 and 2022 (in thousands):
Gain (loss) on assets measured on a nonrecurring basis
Real estate held for sale, net
(492
(143
(1,670
53
242
Total net gain (loss)
(540
291
(1,617
26
The following table presents the primary valuation techniques and unobservable inputs related to Level 3 assets that are recorded on a recurring and nonrecurring basis as of June 30, 2023 ($ in thousands):
Asset category
Fair value
Primaryvaluationtechnique
Unobservableinput
Range
Weightedaverage
Recurring:
Discounted cash flow
Discount rate
9.5% to 11.0%
9.7%
Prepayment rate
0.0% to 50.0%
26.7%
Default rate
0.3% to 94.9%
Loss severity rate
0.0% to 24.8%
2.9%
Recovery lag (performing loans, in months)
8.0%
5.6% to 16.9%
6.9%
Nonrecurring:
Market comparables
Selling costs
The following table presents the primary valuation techniques and unobservable inputs related to Level 3 assets as of December 31, 2022 ($ in thousands):
8.35% to 9.35%
8.9%
1.0% to 30.0%
15.1%
0.12% to 6.99%
0.6%
0.00% 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 periods indicated (in thousands):
450,732
Originations
258,646
456,534
Loans liquidated
(13,464
(21,485
Principal paydowns
(1,764
(2,796
Total unrealized gain included in net income
3,108
Loans transferred to held for sale
(20,857
Loans repurchased
8,072
27
The following is a roll-forward of loans held for sale that are measured at estimated fair value on a recurring basis for the periods indicated (in thousands):
18,080
77,502
87,908
19,088
(17,385
(77,502
(39,945
(223,788
Total unrealized loss included in net income
(695
Loans transferred from (to) held for investment
(390
20,857
135,490
390
The following is a roll-forward of securitized debt that are measured at estimated fair value on a recurring basis for the periods indicated (in thousands):
194,941
Securitized debt additions
201,000
398,487
Securitized debt paydowns
(8,582
(11,297
(5,560
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 June 30, 2023 and December 31, 2022, the only financial assets measured at fair value, or lower of cost or fair value, were certain individually evaluated loans held for investment, loans held for sale, mortgage servicing rights, REO, FVO loans, and securitized debt at fair value, 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 $13.1 million and $11.5 million as of June 30, 2023 and December 31, 2022, net of specific allowance for credit 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 (in thousands):
Carrying
Estimated
Value
Cash
2,879,626
211,634
Warehouse repurchase facilities, net
2,335,949
Accrued interest payable
18,068
3,201,850
Accrued interest receivable
211,854
Securitized debt net
2,522,010
16,369
Note 16 — Subsequent Events
On August 2, 2023, the Company completed the securitization of $85.9 million of investor real estate loans, which will be accounted for as a secured borrowing during the quarter ended September 30, 2023.
The Company has evaluated events that have occurred subsequent to June 30, 2023 through the issuance of the accompanying consolidated financial statements and has concluded there are no other subsequent events that would require recognition or disclosure in the accompanying consolidated financial statements.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion should be read in conjunction with the information included in our Annual Report on Form 10-K for the year ended December 31, 2022, as well as the unaudited financial statements included elsewhere in this Quarterly Report on Form 10-Q (the “Quarterly Report”).
In addition, the statements and assumptions in this Quarterly Report that are not statements of historical fact are forward-looking statements within the meaning of federal securities laws. In particular, statements about our plans, strategies and prospects as well as estimates of industry growth for the next quarter and beyond are forward-looking statements. For important information regarding these forward-looking statements, please see the discussion below under the caption "Forward-Looking Statements.”
References to “the Company,” “Velocity,” “we,” “us” and “our” refer to Velocity Financial, Inc. and include all of its consolidated subsidiaries, unless otherwise indicated or the context requires otherwise.
Business
We are a vertically integrated real estate finance company founded in 2004. We primarily originate and manage investor loans secured by 1-4 unit residential rental and commercial properties, which we refer to collectively as investor real estate loans. We originate loans nationwide across our extensive network of independent mortgage brokers which we have built and refined over the 19 years since our inception. Our objective is to be the preferred and one of the most recognized brands in our core market, particularly within our network of mortgage brokers.
We operate in a large and highly fragmented market with substantial demand for financing and limited supply of institutional financing alternatives. We have developed the highly-specialized skill set required to effectively compete in this market, which we believe has afforded us a durable business model capable of generating attractive risk-adjusted returns for our stockholders throughout various business cycles. We offer competitive pricing to our borrowers by pursuing low-cost financing strategies and by driving front-end process efficiencies through customized technology designed to control the cost of originating a loan. Furthermore, by originating loans through our efficient and scalable network of approved mortgage brokers, we are able to maintain a wide geographical presence and nimble operating infrastructure capable of reacting quickly to changing market environments.
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 June 30, 2023, has an average balance of approximately $390 thousand. As of June 30, 2023, our loan portfolio totaled $3.7 billion of UPB on properties in 45 states and the District of Columbia. The total portfolio had a weighted average loan-to-value ratio, or LTV at origination, of 68.2%, of which the 1-4 unit residential rental loans, which we refer to as investor 1-4 loans, represented 54.2% of the UPB. For the three months ended June 30, 2023, the annualized yield on our total portfolio was 8.24%.
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 financing. We have successfully executed twenty-eight securitized debt, resulting in a total of over $5.7 billion in gross debt proceeds from May 2011 through June 2023. We may also continue to sell loans from time to time for cash in lieu of holding the loans in our loan portfolio.
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 three months ended June 30, 2023, our annualized portfolio related net interest margin was 3.24%, relatively flat compared to the 3.23% for the quarter ended March 31, 2023. 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 three and six months ended June 30, 2023, including net income attributable to noncontrolling interest, we generated pre-tax income of $16.8 million and $31.6 million, and net income of $12.2 million and $23.0 million, respectively.
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.
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.
We have made an election to apply the fair value option ("FVO") accounting to all our originated mortgage loans on a go-forward basis beginning October 1, 2022. The fair value option loans are 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 fair value option ("FVO") accounting to 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.
Recent Developments
Securitized Debt
During the quarter ended June 30, 2023, we completed two securitizations, VCC 2023-1R and VCC 2023-2. $64.8 million of securities were issued by VCC 2023-1R, and $202.2 million of securities were issued by VCC 2023-2. Securities issued by VCC 2023-1R are collateralized by retained tranches from previous VCC securitizations issued between 2019 to 2023. Securities issued by VCC 2023-2 are collateralized by long term mortgage loans.
Continued Market Uncertainties
Our operational and financial performance will depend on certain market developments, including any lingering impact of the COVID-19 pandemic, the Russia/Ukraine war, a global recession, heightened stress in the 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 Policies and Use of Estimates
The preparation of financial statements in accordance with U.S. GAAP requires certain judgments and assumptions, based on information available at the time of preparation of the consolidated financial statements, in determining accounting estimates used in preparation of the consolidated financial statements. The following discussion addresses the accounting policies that we believe apply to us based on the nature of our operations. Our most critical accounting policies involve decisions and assessments that could affect our reported assets and liabilities, as well as our reported revenues and expenses. We believe that all the decisions and assessments used to prepare our financial statements are based upon reasonable assumptions given the information available at that time.
These polices and estimates relate to the allowance for loan losses and deferred income tax assets and liabilities. Our critical accounting policies and estimates are described in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2022, as filed with the SEC.
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.
Factors Affecting Our Results of Operations
Our results of operations depend on, among other things, the level of our net interest income, the credit performance of our loan portfolio and the efficiency of our operating platform. These measures are affected by a number of factors, including the demand for investor real estate loans, the competitiveness of the market for originating or acquiring investor real estate loans, the cost of financing our portfolio, operating costs, the availability of funding sources and the underlying performance of the collateral supporting our loans. While we have been successful at managing these elements in the past, there are certain circumstances beyond our control, including any lingering impact of the COVID-19 pandemic, the Russia/Ukraine war, an expected recession, and macroeconomic conditions and market fundamentals, which can all affect each of these factors and potentially impact our business performance.
Competition
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 six warehouse repurchase and revolving loan facilities have interest payment obligations tied to the one-month American Interbank Offered Rate, ("AMERIBOR"). Five of our warehouse repurchase and revolving loan facilities have interest payment obligations tied to the Secured Overnight Offering Rate ("SOFR").
Loan Performance
We underwrite and structure our loans to minimize potential losses. We believe our fully amortizing loan structures and avoidance of large balloon payments, coupled with meaningful borrower equity in properties, limit the probability of losses and that our proven in-house asset management capability allows us to minimize potential losses in situations where there is insufficient equity in the property. Our income is highly dependent upon borrowers making their payments and resolving delinquent loans as favorably as possible. Macroeconomic conditions can, however, impact credit trends in our core market and have an adverse impact on financial results.
Macroeconomic Conditions
The investor real estate loan market may be impacted by a wide range of macroeconomic factors such as interest rates, residential and commercial real estate prices, home ownership and unemployment rates, and availability of credit, among others. We believe our prudent underwriting, conservative loan structures and interest rate protections, and proven in-house asset management capability leave us well positioned to manage changing macroeconomic conditions.
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Portfolio and Asset Quality
Key Portfolio Statistics
March 31, 2023
June 30, 2022
Total loans
3,596,176
3,090,258
Loan count
9,541
9,147
7,779
Average loan balance
393
397
Weighted average loan-to-value
68.2
68.1
Weighted average coupon
8.4
8.2
7.5
Nonperforming loans (UPB) (A)
371,154
309,937
252,253
Nonperforming loans (% of total) (A)
10.0
8.6
(A) Reflects the UPB of loans 90 days or more past due or placed on nonaccrual status. Includes $43.5 million, $38.7 million, and $45.9 million of COVID-19 forbearance-granted loans 90 days or more past due or placed on nonaccrual status as of June 30, 2023, March 31,2023, and June 30, 2022, 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 credit 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.
Nonperforming Loans. Loans that are 90 or more days past due, in bankruptcy, in foreclosure, or not accruing interest, except for certain loans in our COVID-19 forbearance program, 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.
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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
Three Months Ended June 30, 2023:
Loan originations — held for investment
722
358
11.00
67.7
Loan originations — held for sale
(—
)%
Total loan originations
Loan acquisitions — held for investment
Total loans originated
Three Months Ended March 31, 2023:
197,888
337
11.08
66.6
9,544
5.34
47.5
589
216,976
368
10.58
65.0
Three Months Ended June 30, 2022:
1,072
445,424
7.75
69.7
492
7.74
60.0
Total loans originated and acquired
1,073
445,916
During the second quarter of 2023, we originated $258.6 million of loans, which is an increase of $41.7 million from $217.0 million for the three months ended March 31, 2023 and a decrease of $186.8 million from $445.4 million for the quarter ended June 30, 2022. The decrease from June 2022 is primarily as a result of increased interest rates and strategically reducing originations.
Loans Held for Investment and Loans Held for Investment at Fair Value
Our total portfolio of loans held for investment consists of both loans held for investment at amortized cost, which are presented in the consolidated balance sheet 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:
Total loans held for investment, gross
Allowance for credit losses
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:
Loans due in less than one year
141,299
3.8
146,916
4.2
89,251
2.9
Loans due in one to five years
36,051
31,777
28,264
Loans due in more than five years
3,542,475
95.2
3,333,793
94.9
2,972,743
96.2
100.0
Allowance for Loan Losses
For the December 31, 2022 CECL estimate, we used a severe stress scenario with an eight-quarter reasonable and supportable forecast period followed by a two-quarter straight-line reversion period. We considered the potential impact of the Omicron variant and the effect of the variant on further supply chain disruptions. We also considered lower than forecasted employment numbers, expiring unemployment benefits, and an upcoming flu season.
For the March 31, 2023 estimate, we 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 uncertainty around future COVID cases, the war between Russia and Ukraine, spike in inflation, continued disruption in the supply chain, and concerns of a recession.
For the June 30, 2023 estimate, we 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 war between Russia and Ukraine, continued disruption in the supply chain, and concerns of a recession.
Our allowance for loan losses as of June 30, 2023 was $4.6 million compared to $4.9 million as of December 31, 2022 and $4.9 million as of June 30, 2022. The decrease in allowance for credit losses from December 31, 2022 and from June 30, 2022 was primarily due to loan payoffs decreasing the non-FVO loan portfolio. 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. The various scenarios, the weighting of scenarios, as well as the forecast period and reversion to historical loss, is subject to change as conditions in the market change and the Company’s ability to forecast economic events evolves.
To estimate the allowance for loan losses in our non-FVO loans held for investment portfolio, we follow a detailed internal review 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:
Total loans held for investment (UPB), excluding FVO (1)
3,088,950
Allowance for credit losses / loans held for investment, excluding FVO
0.15
0.16
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:
June 30, 2023 (A)
COVID-19Forbearance
December 31, 2022 (A)
June 30, 2022 (A)
Performing/Accruing:
3,114,091
83.7
123,443
2,969,989
84.6
120,884
2,692,799
87.1
168,774
30-59 days past due
164,586
4.4
9,995
186,051
5.3
33,668
105,808
3.4
15,741
60-89 days past due
69,994
1.9
4,981
63,657
1.8
6,902
39,398
1.3
3,357
90+ days past due
Total Performing Loans
3,348,671
90.0
3,219,697
91.7
161,454
2,838,005
91.8
187,872
Nonperforming/Nonaccrual:
<90 days past due
23,125
0.6
5,066
0.5
1,116
16,878
2,545
39,536
1.1
2,088
32,566
1,681
20,341
0.7
5,853
Bankruptcy
20,256
1,130
22,435
7,272
19,560
3,551
In foreclosure
288,237
7.8
35,236
219,936
6.3
29,482
195,474
36,493
Total nonperforming loans
292,789
8.3
39,551
48,442
236,314
Other than loans 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 $371.2 million, or 10.0% of our held for investment loan portfolio as of June 30, 2023, compared to $292.8 million, or 8.3% as of December 31, 2022, and $252.3 million, or 8.2% of the held for investment loan portfolio as of June 30, 2022. We believe the significant equity cushion at origination and the active management of loans will continue to minimize credit losses on the resolution of defaulted loans and disposition of REO properties.
35
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 became nonperforming prior to the beginning of the periods indicated or became nonperforming and subsequently resolved during the periods indicated. We resolved $43.6 million of long-term and short-term non-performing loans during the quarter ended June 30, 2023, which was higher compared to $36.9 million during the quarter ended March 31, 2023 and lower compared to $47.1 million during the quarter ended June 30, 2022. We also resolved $6.5 million of nonperforming loans transferred to REO during the quarter ended June 30, 2023, which was higher compared to $1.8 million and $3.4 million during the quarter ended March 31, 2023 and June 30, 2022. From these resolution activities, we realized net gains of $1.5 million, $1.3 million, and $5.7 million during the quarters ended June 30, 2023, March 31, 2023, and June 30, 2022, respectively. This is largely the result of collecting default interest and prepayment penalties in excess of the contractual principal and interest due on loans.
The table below includes resolutions for our long-term nonperforming loans and REO's.
Three Months Ended
Long-Term Loans
Gain /(Loss)
Resolved — paid in full
13,485
965
11,274
632
16,934
3,303
Resolved — paid current
19,771
280
18,477
233
17,407
129
Resolved — REO sold
4,836
(382
570
2,107
Total resolutions
38,092
863
30,321
1,002
36,448
4,248
Recovery rate on resolved nonperforming UPB
102.3
103.3
111.7
The table below includes resolutions for our short-term nonperforming loans and REO's, 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 and Forbearance Loans
7,004
318
348
9,913
976
89
1,633
2,877
1,672
222
1,209
(21
1,262
500
11,966
629
8,402
336
14,052
1,498
105.3
104.0
110.7
Our charge-offs incurred have been small as a percentage of nonperforming loans held for investment. The table below shows our actual loan losses for the periods indicated.
Six Months Ended
Average nonperforming loans for the period (1)
313,800
298,703
267,998
484
366
Charge-offs / Average nonperforming loans for the period (1)
0.76
(2)
0.65
0.27
Concentrations – Loans Held for Investment
As of June 30, 2023, our held for investment loan portfolio was concentrated in investor 1-4 loans, representing 54.2% of the UPB. Mixed used properties represented 12.2% of the UPB. No other property type represented more than 10.0% of our held for investment loan portfolio. Geographically, the principal balance of our loans held for investment were concentrated 21.7% in California, 19.2% in New York, 14.0% in Florida, and 7.4% in New Jersey.
Property Type
% of Total UPB
Investor 1-4
5,837
2,016,017
54.2
Mixed use
1,093
452,418
12.2
Retail
668
321,828
Multifamily
303,682
Warehouse
364
235,264
Office
463
194,654
5.2
Other(1)
564
195,962
Geography (State)
California
806,195
21.7
New York
1,300
713,750
19.2
Florida
1,312
520,627
14.0
New Jersey
273,423
4,800
1,405,830
37.7
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 credit losses. Positive adjustments at the time of foreclosure are recognized in other operating income. Subsequent to foreclosure, we periodically obtain new valuations, reductions in fair value are reflected as valuation adjustments.
As of June 30, 2023, our REO included 45 properties with a lower of cost or estimated fair value of $20.4 million compared to 39 properties with a lower of cost or estimated fair value of $21.8 million as of March 31, 2023.
Key Performance Metrics
June 30, 2023 (1)
March 31, 2023 (1)
June 30, 2022 (1)
Average loans
3,637,570
3,525,028
2,973,680
Portfolio yield
8.24
8.00
7.97
Average debt — portfolio related
3,258,651
3,151,650
2,651,300
Average debt — total company
3,473,651
3,366,650
2,866,300
Cost of funds — portfolio related
5.58
5.33
4.34
Cost of funds — total company
5.71
5.49
4.60
Net interest margin — portfolio related
3.24
3.23
4.10
Net interest margin — total company
2.78
2.76
3.54
Charge-offs/Average loans held for investment, excluding FVO loans
0.09
0.06
Pre-tax return on equity
16.81
15.26
16.42
Return on equity
12.21
11.10
12.06
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.
37
Portfolio Yield
Portfolio yield is an annualized measure of the total interest income earned on our loan portfolio as a percentage of average loans over the given period. Interest income includes interest earned on performing loans, cash interest received on nonperforming loans, default interest and prepayment fees. The fluctuations in our portfolio yield over the periods shown was primarily driven by loans placed on non-accrual status during the periods.
Average Debt — Portfolio Related and Total Company
Portfolio-related debt consists of borrowings related directly to financing our loan portfolio, which includes our warehouse facilities and securitized debt. Total company debt consists of portfolio-related debt and corporate debt. The measures presented here reflect 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 three months ended June 30, 2023 from 5.33% for the three months ended March 31, 2023 and increased from 4.34% for the three months ended June 30, 2022.
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 of 3.24% for the three months ended June 30, 2023 remained consistent with the 3.23% for the three months ended March 31, 2023, and decreased from 4.10% for the three months ended June 30, 2022. The decrease from June 30, 2022 was primarily due to higher debt cost caused by an overall increase in interest rates.
Our total company net interest margin decreased to 2.78% for the three months ended June 30, 2023 from 3.54% for the three months ended June 30, 2022 and remained consistent from 2.76% for the three months ended March 31, 2023, respectively. The decrease in total company net interest margin during the three months ended June 30, 2023 from the three months ended June 30, 2022 was primarily due to higher interest rates as compared to the same period in 2022.
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The following tables show the average outstanding balance of our loan portfolio and portfolio-related debt, together with interest income and the corresponding yield earned on our portfolio, and interest expense and the corresponding rate paid on our portfolio-related debt for the periods indicated:
Interest
Average
Income /
Yield /
Balance
Expense
Rate (1)
Loan portfolio:
Loans held for sale
3,477
12,896
62,987
Loans held for investment
3,634,093
3,512,133
2,910,693
3,525,029
70,521
Debt:
Warehouse facilities
225,497
4,833
8.57
3,020,624
5.24
2,926,153
37,196
5.08
2,332,340
4.23
Total debt - portfolio related
42,029
Corporate debt
7.70
7.78
Total debt
46,168
Net interest spread - portfolio related (2)
2.66
2.67
3.63
Net interest margin - portfolio related
Net interest spread - total company (3)
2.53
2.52
3.37
Net interest margin - total company
Charge-Offs
Our annualized charge-off rate over average loans held for investment carried at amortized cost for the three months ended June 30, 2023 increased to 0.09% as compared to 0.06% for the three months ended March 31, 2023 and decreased as compared to 0.27% for the three months ended June 30, 2022. The charge-offs rate reflects year-to-date annualized charge-offs as a percentage of average loans held for investment for the respective quarters. We do not record charge-offs on FVO loans which are carried at estimated fair value. We do not record charge-offs on our loans held for sale which are carried either at fair value or 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 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 were higher during the quarter ended June 30, 2023 compared to the quarters ended March 31, 2023 and the quarter ended June 30, 2022 due to the increase in income before income taxes and net income.
Income before income taxes (A)
14,757
14,664
Net income (B)
Monthly average balance:
Stockholders' equity (C)
400,441
386,935
357,218
Pre-tax return on equity (A)/(C) (1)
16.8
15.3
16.4
Return on equity (B)/(C) (1)
11.1
12.1
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 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 our FVO loans.
Other Operating Income
Gain on Disposition of Loans. When we sell a loan held for sale, we record a gain or loss that reflects the difference between the proceeds received for the sale of the loans and their respective carrying values. The gain or loss that we ultimately realize on the sale of our loans held for sale is primarily determined by the terms of the originated loans, current market interest rates and the sales price of the loans. In addition, when we transfer a loan to REO, we record the REO at its fair value at the time of the transfer. The difference between the fair value of the real estate and the carrying value of the loan is recorded as a gain or 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 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 Income. Fee income related to our loan origination activities.
Bank Interest Income. Interest income on bank balances.
Other Income. Other income includes the following:
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.
Servicing Fee Income. Century earns servicing fees for servicing mortgage loans for others.
Valuation Allowance on Loans Held for Sale.For loans held for sale that are carried at the lower of cost or estimated fair value, the adjustments of the carrying value to estimate fair value are reported as valuation allowance.
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.
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.
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Consolidated Results of Operations
The following table summarizes our consolidated results of operations for the periods indicated:
Interest expense - portfolio related
Net interest income - portfolio related
Interest expense - corporate debt
$ Change
15,654
34,126
16,699
35,172
(1,045
(1,046
Portfolio related net interest income is the largest contributor to our net income. Our portfolio related net interest income remained relatively consistent decreasing to $29.4 million from $30.5 million for the three months ended June 30, 2023 and 2022. Our portfolio related net interest income decreased from $59.0 million for the six months ended June 30, 2022 to $58.0 million for the six months ended June 30, 2023.
Interest Income. Interest income increased by $15.7 million to $74.9 million for the three months ended June 30, 2023, compared to $59.2 million for the three months ended June 30, 2022. The increase was primarily attributable to higher portfolio balances and an increase in the average loan yield, which increased from 7.97% for the three months ended June 30, 2022 to 8.24% for the three months ended June 30, 2023. Interest income increased by $34.1 million to $145.4 million for the six months ended June 30, 2023, compared to $111.3 million for the six months ended June 30, 2022. The increase in six months ended June 30, 2023 was primarily attributable to higher portfolio balances due to loan originations and higher average loan yield.
The following tables distinguish between the change in interest income attributable to change in volume and the change in interest income attributable to a change in rate for the three and six months ended June 30, 2023 and 2022, respectively. The effect of changes in volume is determined by multiplying the change in average loan balance (i.e., $0.7 billion) by the previous period’s average yield (i.e., 7.97%). The effect of rate changes is calculated by multiplying the change in average yield (i.e., (0.27%) by the current period’s average loan balance (i.e., $3.6 billion).
Three Months Ended June 30, 2023 and 2022
AverageLoans
InterestIncome
AverageYield (1)
Three months ended June 30, 2023
Three months ended June 30, 2022
Volume variance
663,890
13,228
Rate variance
2,426
Total interest income variance
(1) Annualized.
42
Six Months Ended June 30, 2023 and 2022
3,581,299
8.12
2,828,266
7.87
753,033
29,632
4,494
0.25
Interest Expense — Portfolio Related. Portfolio related interest expense, which consists of interest incurred on our warehouse facilities and securitized debt, increased from $28.8 million for the three months ended June 30, 2022 to $45.5 million for the three months ended June 30, 2023, and increased from $52.3 million for the six months ended June 30, 2022 to $87.5 million for the six months ended June 30, 2023, primarily attributable to a higher loan portfolio being financed and increased interest rates.
The following tables present the information regarding the portfolio related interest expense and distinguishes between the change in interest expense attributable to changes in the average outstanding debt balance (volume) versus changes in cost of funds (rate) for the three and six months ended June 30, 2023 and 2022, respectively.
AverageDebt (1)
InterestExpense
Cost of Funds (2)
607,351
6,590
10,109
1.24
Total interest expense variance
Cost ofFunds (2)
3,205,150
5.46
2,503,866
4.18
701,284
14,657
20,515
1.28
Net Interest Income After Provision for Loan Losses
(13,044
(1,002
(1,021
12,074
Interest Expense — Corporate Debt. Corporate debt interest expense decreased to $4.1 million for the three months ended June 30, 2023, compared to $4.2 million for the three months ended June 30, 2022, and decreased to $8.3 million for the six months ended June 30, 2023, compared to $21.3 million for the six months ended June 30, 2022, primarily due to the $12.8 million prepayment fee and unamortized debt issuance costs associate with the payoff of our corporate debt in March 2022.
Provision for Loan Losses. Our provision for loan losses remained consistent at $0.3 million for the three months ended June 30, 2023 and 2022, and decreased from $1.0 million for the six months ended June 30, 2022 to $0.9 million for the six months ended June 30, 2023, primarily due to a decrease in our loans held for investment portfolio carried at amortized cost. The loans held for investment portfolio decreased due to paydowns on our existing amortized cost portfolio and the election of fair value option accounting on all new loan originations effective October 1, 2022.
The $10.7 million increase in total other operating income during three months ended June 30, 2023 and $17.6 million increase for the six months ended June 30, 2023 was mainly due to the election of fair value option accounting on new loan originations beginning October 1,2022, and the election of fair value option accounting on certain securitized debt effective January 1, 2023.
$1,237
$1,776
$(539)
$3,149
$6,317
$(3,168)
2,407
9,751
(1)
2,181
3,958
(353)
(1,063)
$14,037
$3,592
$10,445
$26,878
$9,873
$17,005
Operating expenses are presented in the following table. Changes in operating expenses comparing to the same periods prior year are discussed below.
$10,670
$6,553
$4,117
$20,678
$11,876
$8,802
(1,381)
(2,375)
977
2,354
(6)
(412)
(251)
1,269
(426)
3,272
(317)
(653)
$22,222
$14,832
$7,390
$44,024
$27,715
$16,309
Compensation and Employee Benefits. Compensation and employee benefits increased by $4.1 million to $10.7 million for the three months ended June 30, 2023 compared to $6.6 million for the three months ended June 30, 2022, and increased by $8.8 million to $20.7 million for the six months ended June 30, 2023 compared to $11.9 million for the six months ended June 30, 2022. 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.
Origination (Income) Expenses. Origination expenses decreased to an income of $0.2 million for the three months ended June 30, 2023, compared to an expense of $1.0 million for the three months ended June 30, 2022, and decreased to an income of $0.6 million for the six months ended June 30, 2023, compared to an expense of $1.3 million for the six months ended June 30, 2022. The increase in origination income was due to an increase in fee income on loan originations.
Securitization Expenses. The increase in securitization expenses of $2.7 million and $5.3 million for the three and six months ended June 30, 2023 was 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 at amortized cost.
Loan Servicing. Loan servicing expenses increased from $3.3 million for the three months ended June 30, 2022 to $4.3 million for the three months ended June 30, 2023, and increased from $5.7 million for the six months ended June 30, 2022 to $8.1 million for the six months ended June 30, 2023, primarily attributable to the increase in our loan portfolio.
Professional Fees. Professional fees remained consistent at $1.1 million for the three months ended June 30, 2023 and 2022, and decreased by $0.4 million to $2.0 million for the six months ended June 30, 2023 as compared to $2.4 million for the six months ended June 30, 2022, mainly due to an overall decrease in consulting fees in 2023.
Rent and Occupancy. Rent and occupancy expenses remained consistent at $0.4 million and $0.9 million for the three and six months ended June 30, 2023 and 2022.
44
Net Expenses of Real Estate Owned. Net expenses of real estate owned increased from income of $0.3 million for the three months ended June 30, 2022 to expense of $1.0 million for the three months ended June 30, 2023, and increased from income of $0.4 million for the six months ended June 30, 2022 to expense of $2.8 million for the six months ended June 30, 2023, mainly due to the decrease in realized gain on REO disposition and the increase in valuation adjustments taken on the underlying collateral values.
Other Operating Expenses. Other operating expenses decreased from $2.2 million for the three months ended June 30, 2022 to $1.9 million for the three months ended June 30, 2023, and decreased from $4.8 million for the six months ended June 30, 2022 to $4.1 million for the six months ended June 30, 2023, mainly attributable to the decrease in reserve for repurchase of loans.
Income Tax Expense. Income tax expense was $4.6 million and $4.0 million for the three months ended June 30, 2023 and 2022, and $8.6 million and $4.8 million for the six months ended June 30, 2023 and 2022, respectively. Our annual consolidated effective tax rates were 27.6% and 27.4% for the years 2023 and 2022 respectively.
Quarterly Results of Operations
The following table sets forth certain financial information for each completed fiscal quarter since the quarter ended September 30, 2021. The quarterly information has been prepared on the same basis as the consolidated financial statements and includes all adjustments (consisting of normal recurring adjustments) that, in the opinion of management, are necessary for a fair presentation of the information presented. This information should be read in conjunction with the consolidated financial statements and related notes thereto included elsewhere in this Quarterly Report. Operating results for interim periods are not necessarily indicative of the results that may be expected for a full fiscal year.
The following table sets forth our unaudited quarterly results for the periods indicated:
June 30,2023
March 31,2023
December 31,2022
September 30,2022
June 30,2022
March 31,2022
December 31,2021
September 30,2021
(unaudited)
65,632
63,419
52,049
49,360
46,923
40,854
34,561
23,556
23,666
20,321
28,492
24,778
28,858
28,493
25,694
26,602
2.84
3.59
4.25
4.27
4.97
4,011
17,140
4,462
4,488
24,353
20,639
24,847
11,353
21,232
22,114
2.36
3.09
1.69
3.53
4.13
Provision for (reversal of) loan losses
636
(437
580
730
377
228
23,717
21,076
24,267
10,623
20,855
21,886
12,843
11,420
3,027
6,281
3,190
719
21,803
20,804
13,245
12,883
12,668
11,678
11,692
14,049
4,021
11,377
10,927
Less income attributable to noncontrolling interest
(235
307
3,465
3,759
790
3,024
2,905
8,462
9,983
8,353
8,022
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.
45
Cash and Cash Equivalents
Our total liquidity plus available warehouse capacity including Century's revolving credit line was $648.0 million as of June 30, 2023 comprised of $34.0 million in cash, $38.0 million of available borrowings for unencumbered loans, $573.0 million of available warehouse capacity, and $3.0 million revolving credit line.
We had cash of $34.0 million and $46.3 million, excluding restricted cash of $16.8 million and $9.2 million as of June 30, 2023 and 2022, respectively. 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
Investing activities
Financing activities
Net change in cash, cash equivalents, and restricted cash
Cash flows from operating activities primarily includes net income adjusted for (1) cash used for origination and purchase of held for sale loans and the related cash proceeds from the sales of such loans, (2) non-cash items including depreciation, provision for loan loss, discount accretion, and valuation changes, and (3) changes in the balances of operating assets and liabilities.
For the six months ended June 30, 2023, our net cash used in operating activities consisted mainly of $23.0 million in net income, $19.8 million in proceeds from sales of loans held for sale, partially offset $19.1 million in origination of loans held for sale.
For the six months ended June 30, 2023, our net cash used in investing activities consisted mainly of $456.5 million in cash used to originate held for investment loans, partially offset by $21.5 million proceeds from sales of loans and $221.4 million in cash received in payoffs of loans held for investment.
For the six months ended June 30, 2023, our net cash provided by financing activities consisted mainly of $463.0 million in borrowings from our warehouse and repurchase facilities and $461.7 million in proceeds of asset-backed securities issued. The cash generated was offset by repayments of $557.8 million on our warehouse and repurchase facilities and repayments of $196.5 million on asset-backed securities issued.
During the six months ended June 30, 2023, we used approximately $11.3 million of net cash and cash equivalents from operations, investing and financing activities. During the six months ended June 30, 2022, we generated approximately $7.9 million of net cash and cash equivalents from operations, investing and financing activities.
Warehouse Facilities
As of June 30, 2023, 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, one of the warehouse facilities bear interest at one-month AMERIBOR and five warehouse facilities at SOFR, all at margins that range from 1.60% to 4.50%. Borrowing under these facilities was $237.0 million with $573.0 million of available capacity under our warehouse and repurchase facilities as of June 30, 2023.
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. The warehouse facilities also contain customary covenants, including financial covenants that require us to maintain minimum liquidity, a minimum net worth, a maximum debt-to-net worth ratio and a ratio of a minimum earnings before interest, taxes, depreciation and amortization of 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 June 30, 2023, we were in compliance with these covenants.
46
From May 2011 through June 2023, we have completed twenty-eight securitized debts, issuing $5.7 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 secured borrowings under U.S. GAAP. The following table summarizes the securities issued, securities retained by us at the time of the securitization, and as of June 30, 2023 and December 31, 2022, and the stated maturity for each securitized debt. 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.
Securities Retained as of
Trusts
SecuritiesIssued
IssuanceDate
Stated MaturityDate
319,809
38,792
17,624
17,541
April 2046
245,601
12,927
2,468
2,697
October 2047
176,816
9,308
1,801
2,065
April 2048
307,988
16,210
4,047
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
4,451
4,718
February 2052
241,388
11,202
11,170
March 2052
84,967
40,911
45,044
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
4,820,966
476,169
235,223
236,515
47
The following table summarizes outstanding bond balances for each securitized debt as of June 30, 2023 and December 31, 2022:
17,704
22,369
51,930
59,183
36,882
43,596
87,984
93,792
83,435
91,167
76,284
82,508
63,278
67,899
121,074
136,643
53,309
60,445
183,089
196,969
156,681
170,072
167,652
178,038
257,369
273,489
246,883
256,667
226,763
233,045
39,862
54,528
268,008
280,066
289,929
301,856
177,075
186,577
189,763
63,390
199,864
3,058,208
2,788,909
As of June 30, 2023 and December 31, 2022, the weighted average rates on the securities and certificates for the Trusts are as follows:
9.29
8.59
3.95
3.92
4.07
4.05
4.51
4.46
4.04
4.06
3.45
3.46
3.29
3.25
2.86
2.89
4.61
1.76
1.73
2.03
2.02
2.46
2.44
3.22
3.20
3.93
5.10
5.07
6.90
6.91
5.69
5.67
6.25
6.23
7.07
7.10
7.02
7.73
7.17
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), agreements, warehouse 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.
48
Secured Financing (Corporate Debt)
On March 15, 2022, we entered into a five-year $215.0 million syndicated corporate debt agreement, the (“the 2022 Term Loan”). The 2022 Term Loan bears interest at a fixed rate of 7.125% and matures on March 15, 2027. A portion of the net proceeds from the 2022 Term Loan was used to redeem all the amounts owed pursuant to a term loan previously entered into during 2021. The remaining portion of the net proceeds from the 2022 Term Loan is used for loan originations and general corporate purposes.
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. For the three months ended June 30, 2023, 1,814 shares of common stock were sold under our ATM Program for net proceeds of $21.4 thousand.
Contractual Obligations and Commitments
On March 15, 2022, we entered into a five-year $215.0 million syndicated corporate debt agreement, the (“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.
As of June 30, 2023, we maintained warehouse facilities to finance our investor real estate loans and had approximately $237.0 million in outstanding borrowings with $573.0 million of available capacity under our warehouse and repurchase facilities.
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.
Forward-Looking Statements
This Form 10-Q 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 Quarterly 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” or “continue” or the negatives of these terms or variations of them or similar terminology. Forward-looking statements may contain expectations regarding our operations, including our loan originations, our ability to resolve non-performing loans and avoid losses on non-performing loans and the disposition of REOs and other results, and may include statements of future performance, plans and objectives. Forward looking statements also include statements pertaining to our strategies for future funding and development of our business and products, including the future results of our at-the-market equity offering program. Although we believe that the expectations reflected in these forward-looking statements have a reasonable basis, 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 operations, results of operations and future financial performance. It is possible that the actual results may differ, possibly materially, from the anticipated results indicated in these forward-looking statements. Information regarding important factors that could cause actual results to differ, perhaps materially, from those in our forward-looking statements is contained in this Quarterly Report and other documents we file. You should read and interpret any forward-looking statement together with these documents, including the following:
Any forward-looking statement speaks only as of the date on which that statement is made. We will not update any forward-looking statement to reflect events or circumstances that occur after the date on which the statement is made, except as required by applicable law.
49
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Not applicable.
Item 4. 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 Rules 13a-15(e) and 15d-15(e) under the Exchange Act as of the end of the period covered by this report. Our disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and that such information is accumulated and communicated to the our management, including the our Chief Executive Officer and Chief Financial Officer to allow timely decisions regarding required disclosure. 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.
In accordance with Rule 13a-15(b) of the Exchange Act, our management, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this quarterly report and has concluded that our disclosure controls and procedures, as of such date, were effective to accomplish their objectives at a reasonable assurance level. Management concluded that the consolidated financial statements for the periods covered by and included in this Quarterly Report on Form 10-Q fairly present, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with U.S. GAAP.
Changes in Internal Control over Financial Reporting.
During the period to which this report relates, there have not been any changes in the Company's internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that have materially affected, or that are reasonably likely to materially affect, such controls.
PART II—OTHER INFORMATION
Item 1. 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. 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 1A. Risk Factors.
Intentionally omitted pursuant to smaller reporting company reduced disclosure requirements.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
No common stock purchases were made by us during the three months ended June 30, 2023.
Item 3. Defaults Upon Senior Securities.
Item 4. Mine Safety Disclosures.
Item 5. Other Information.
Insider Trading Arrangements and Policies
None of our officers or directors had any contract, instruction, or written plan for the purchase or sale of our securities that was intended to satisfy the affirmative defense conditions of Rule 10b5-1(c ) or any “non-Rule 10b5-1 trading arrangement” in effect at any time during the three months ended June 30, 2023.
Item 6. Exhibits.
The exhibits below are filed as part of, or incorporated by reference into, this Quarterly Report on Form 10-Q.
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
Form of Stock Certificate for Common Stock
S-1
333-234250
10/18/2019
Form of Warrant to Purchase Common Stock
4/7/2020
4.3
Description of the Registrant’s Securities
10K
10.1
Stockholders Agreement, dated as of January 16, 2020
10-K
10.2
Registration Rights Agreement, dated as of January 16, 2020
10.3
Registration Rights Agreement, dated as of April 7, 2020
10.4
Securities Purchase Agreement among Velocity Financial, Inc. and the Purchasers Party thereto dated April 5, 2020
4/6/2020
10.5
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*
10.9
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 2023 Annual Cash Incentive and Performance Stock Units Programs for Messrs. Farrar, Szczepaniak and Taylor*
-
1/17/2023
10.14
Form of Equity Distribution Agreement, dated September 3, 2021
9/7/2021
10.15
Form of Officer and Director Indemnity Agreement*
10.37
11/6/2019
10.16
Form of Performance Stock Unit Grant and Agreement*
10.17
Note Purchase Agreement Dated as of March 15, 2022, among Velocity Financial, Inc., Velocity Commercial Capital, LLC, U.S. Bank Trust Company, National Association, as collateral agent, and the respective purchasers of the Notes.
3/16/2022
10.18
Security Agreement, dated as of March 15, 2022, among Velocity Financial, Inc., Velocity Commercial Capital, LLC and U.S. Bank Trust Company, National Association, as collateral agent.
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
32.1
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: (i) the Consolidated Balance Sheets as of June 30, 2023 and December 31, 2022 (ii) the Consolidated Statements of Income for the quarter ended June 30, 2023 and June 30, 2022, (iii) the Consolidated Statements of Changes in Stockholders’ Equity for the quarter ended June 30, 2023 and June 30, 2022, (iv) the Consolidated Statements of Cash Flows for the quarter ended June 30, 2023 and June 30, 2022 and (v) the Notes to unaudited Consolidated Financial Statements.
101.INS
Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document
101.SCH
Inline XBRL Taxonomy Extension Schema Document
101.CAL
Inline XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF
Inline XBRL Taxonomy Extension Definition Linkbase Document
101.LAB
Inline XBRL Taxonomy Extension Label Linkbase Document
101.PRE
Inline XBRL Taxonomy Extension Presentation Linkbase Document
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
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.
Date: August 3, 2023
By:
/s/ Christopher D. Farrar
Christopher D. Farrar
Chief Executive Officer
Date: August 3 2023
/s/ Mark R. Szczepaniak
Mark R. Szczepaniak
Chief Financial Officer