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 March 31, 2021
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 April 30, 2021, the registrant had 20,567,494 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
3
Consolidated Statements of Changes in Stockholders’/ Members’ Equity
4
Consolidated Statements of Cash Flows
5
Notes to Unaudited Consolidated Financial Statements
7
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
27
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
48
Item 4.
Controls and Procedures
PART II.
OTHER INFORMATION
Legal Proceedings
49
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
50
SIGNATURES
51
i
PART I—FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited)
VELOCITY FINANCIAL, INC.
(FORMERLY KNOWN AS VELOCITY FINANCIAL, LLC AND SUBSIDIARIES)
CONSOLIDATED BALANCE SHEETS
($ in thousands, except par value amounts)
March 31, 2021
December 31, 2020
(Unaudited)
ASSETS
Cash and cash equivalents
$
20,434
13,273
Restricted cash
6,808
7,020
Loans held for sale, net
—
13,106
Loans held for investment, net
2,008,505
1,948,089
Loans held for investment, at fair value
1,364
1,539
Total loans, net
2,009,869
1,962,734
Accrued interest receivables
11,169
11,373
Receivables due from servicers
77,731
71,044
Other receivables
3,879
4,085
Real estate owned, net
14,487
15,767
Property and equipment, net
3,891
4,145
Net deferred tax asset
9,246
6,654
Other assets
7,325
6,779
Total assets
2,164,839
2,102,874
LIABILITIES
Accounts payable and accrued expenses
65,003
63,361
Secured financing, net
129,666
74,982
Securitizations, net
1,453,386
1,579,019
Warehouse and repurchase facilities, net
203,314
75,923
Total liabilities
1,851,369
1,793,285
MEZZANINE EQUITY
Series A Convertible preferred stock (45,000 shares designated, $0.01 par value; 45,000
shares issued and outstanding)
90,000
STOCKHOLDERS' EQUITY
Preferred stock ($0.01 par value, 25,000,000 shares authorized; 45,000 issued and
outstanding as reflected in Mezzanine Equity)
Common stock ($0.01 par value, 100,000,000 shares authorized at March 31, 2021 and December 31, 2020; 20,567,494 and 20,087,494 shares issued, respectively)
206
201
Additional paid-in capital
204,670
204,190
Retained earnings
18,594
15,198
Total stockholders' equity
223,470
219,589
Total liabilities, mezzanine equity and stockholders' equity
See accompanying Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
Three Months Ended March 31,
2021
2020
Interest income
40,707
44,637
Interest expense — portfolio related
20,832
22,848
Net interest income — portfolio related
19,875
21,789
Interest expense — corporate debt
7,350
6,342
Net interest income
12,525
15,447
Provision for loan losses
105
1,290
Net interest income after provision for loan losses
12,420
14,157
Other operating income
Gain on disposition of loans
2,839
2,618
Unrealized (loss) gain on fair value loans
(2
)
45
Other expense
(36
(1,043
Total other operating income
2,801
1,620
Operating expenses
Compensation and employee benefits
5,186
5,041
Rent and occupancy
463
456
Loan servicing
1,867
2,238
Professional fees
533
1,184
509
1,134
Other operating expenses
2,059
1,997
Total operating expenses
10,617
12,050
Income before income taxes
4,604
3,727
Income tax expense
1,208
1,148
Net income
3,396
2,579
Less undistributed earnings attributable to participating securities
1,281
NA
Net earnings attributable to common stockholders
2,115
Earnings per common share
Basic
0.11
0.13
Diluted
0.10
Weighted average common shares outstanding
20,087
33,407
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ / MEMBERS' EQUITY
($ in thousands)
Common Stock
Members’
Equity
Shares
Par Value
Additional
Paid-in
Capital
Retained
Earnings
Total
Stockholders'
Balance – December 31, 2019
152,844
Cumulative effect of change in accounting principle (1)
(96
Balance - January 1, 2020
152,748
Class A equity units conversion
(92,650
Class D equity units conversion
(60,194
Issuance of common stock
20,087,494
247,539
247,740
Stock-based compensation
207
Balance – March 31, 2020
247,746
2,483
250,430
Balance – December 31, 2020
Restricted stock awarded and earned stock compensation
480,000
226
231
Stock-based compensation - Options
254
Balance – March 31, 2021
20,567,494
(1)
Impact due to adoption of ASU 2016-13, "Measurement of Credit Losses on Financial Instruments", and related amendments on January 1, 2020.
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
301
303
Amortization of right-of-use assets
367
299
Origination of loans held for sale
(96,067
Proceeds from sales of loans held for sale
80,858
Purchase of held for sale loans
(1,950
(203
Repayments on loans held for sale
(121
8,987
Net accretion of discount on purchased loans and deferred loan origination costs
1,368
1,324
Provision for uncollectible borrower advances
261
99
(2,592
(2,271
Real estate acquired through foreclosure in excess of recorded investment
(247
(346
Amortization of debt issuance discount and costs
6,403
6,175
Loss on disposal of property and equipment
1
38
Change in valuation of real estate owned
435
568
Change in valuation of fair value loans
(45
Change in valuation of held for sale loans
(17
40
Gain on sale of real estate owned
(188
(49
485
Net deferred tax benefit
(1,790
(Increase) decrease in operating assets and liabilities:
Accrued interest and other receivables
2,800
1,088
(930
(2,151
3,137
433
Net cash provided by operating activities
10,424
1,366
Cash flows from investing activities:
Purchase of loans held for investment
(3,571
Origination of loans held for investment
(236,484
(153,600
Payoffs of loans held for investment and loans at fair value
124,189
103,384
Proceeds from sales of loans originally classified as held for investment
57,924
Proceeds from sale of real estate owned
2,942
1,202
Capitalized real estate owned improvements
(10
(119
Change in advances
(548
(746
Change in impounds and deposits
(1,620
2,011
Purchase of property and equipment
(625
Net cash used in investing activities
(53,656
(52,064
Cash flows from financing activities:
Warehouse repurchase facilities advances
196,633
250,416
Warehouse repurchase facilities repayments
(68,261
(374,732
Proceeds from secured financing
140,000
Repayment of secured financing
(78,875
(75,000
Proceeds of securitizations, net
248,691
Repayment of securitizations
(128,357
(109,566
Debt issuance costs
(10,959
(3,428
100,800
IPO deal costs
(1,903
Net cash provided by financing activities
50,181
35,278
Net increase (decrease) in cash, cash equivalents, and restricted cash
6,949
(15,420
Cash, cash equivalents, and restricted cash at beginning of period
20,293
27,552
Cash, cash equivalents, and restricted cash at end of period
27,242
12,132
Supplemental cash flow information:
Cash paid during the period for interest
21,594
22,033
Cash paid during the period for income taxes
100
Noncash transactions from investing and financing activities:
Transfer of loans held for investment to held for sale
44,892
Transfer of loans held for investment to real estate owned
1,652
4,352
Transfer of accrued interest to loans held for investment
618
Transfer of loans held for sale to held for investment
1,747
Deferred IPO costs charged against additional paid-in capital
4,000
See accompanying Notes to Consolidated Financial Statements
6
VELOCITY FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited)
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 small balance investor real estate loans, providing capital to the investor real estate loan market. The Company is licensed as a California Finance Lender and, as such, is required to maintain a minimum net worth of $250 thousand. The Company does not believe there is any potential risk of not being able to meet this regulatory requirement. The Company uses its equity capital and borrowed funds to originate and invest in investor real estate loans and seeks to generate income based 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 engage in any other significant line of business or offer any other products or services, nor does it originate or acquire investments outside of the United States of America.
The Company, through its wholly owned subsidiaries, is the sole beneficial owner of the Velocity Commercial Capital Loan Trusts, from the 2014-1 Trust through and including the 2020-MC1 Trust, all of which are New York common law trusts. The Trusts are bankruptcy remote, variable interest entities (VIE) formed for the purpose of providing secured borrowings to the Company and are consolidated with the accounts of the Company.
Note 2 — Basis of Presentation and Summary of Significant Accounting Policies
The consolidated financial statements of the Company have been prepared on the accrual basis of accounting and in accordance with United States Generally Accepted Accounting Principles (U.S. GAAP).
(a)
Partnership to Corporation Conversion
On January 16, 2020, Velocity Financial, LLC converted from a limited liability company to a corporation and changed its name to Velocity Financial, Inc. The Conversion was accounted for in accordance with ASC 805-50 –Business Combinations, as a transaction between entities under common control. All assets and liabilities of Velocity Financial, LLC were contributed to Velocity Financial, Inc. at their carrying value, and the results of operations are being presented as if the Conversion had occurred on January 1, 2020. Additionally, Class A and Class D’s partnership equity at December 31, 2019 were converted to stockholders’ equity and presented as such on the Consolidated Balance Sheets and the Consolidated Statement of Changes in Stockholders’ Equity effective January 1, 2020.
(b)
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosures of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of consolidated income and expenses during the reporting period.
(c)
Significant Accounting Policies
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, 2020 as filed with the Securities and Exchange Commission ("Form 10-K").
There have been no significant changes to the Company’s significant accounting policies as described in its 2020 Annual Report.
(d)
Principles of Consolidation
The principles of consolidation require management to determine and reassess the requirement to consolidate VIEs each reporting period, and therefore, the determination may change based on new facts and circumstances pertaining to each VIE. This could result in a material impact to the Company’s consolidated financial statements in subsequent reporting periods.
The Company consolidates the assets, liabilities, and remainder interests of the Trusts as management determined that VCC is the primary beneficiary of these entities. The Company’s ongoing asset management responsibilities provide the Company with the power to direct the activities that most significantly impact the VIE’s economic performance, and the remainder interests provide the Company with the right to receive benefits and the obligation to absorb losses, limited to its investment in the remainder interest of the Trusts.
The following table presents a summary of the assets and liabilities of the Trusts as of March 31, 2021 and December 31, 2020. Intercompany balances have been eliminated for purposes of this presentation (in thousands):
(in thousands)
6,545
6,743
1,743,227
1,874,991
87,905
82,342
8,836
9,698
10
12
1,846,523
1,973,786
42,734
43,795
Securities issued
1,496,120
1,622,814
The consolidated financial statements as of March 31, 2021 and December 31, 2020 include only those assets, liabilities, and results of operations related to the business of the Company, its subsidiaries, and VIEs.
Note 3 — Current Accounting Developments
Accounting Standards Adopted in 2021
Effective January 1, 2021, the Company adopted ASU 2019-12, “Income Taxes (Topic 740) - Simplifying the Accounting for Income Taxes.” ASU 2019-12 provides guidance to simplify the accounting for income taxes by eliminating certain exceptions to the guidance in ASC 740 related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and the recognition for deferred tax liabilities for outside basis differences. ASU 2019-12 also simplifies aspects of the accounting for franchise taxes and enacted changes in tax laws or rates and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. The adoption of this standard did not have a significant impact on the Company’s consolidated financial statements.
ASU 2020-08, “Codification Improvements to Subtopic 310-20, Receivables - Nonrefundable Fees and Other Costs.” ASU 2020-08 clarifies the accounting for the amortization of purchase premiums for callable debt securities with multiple call dates. The adoption this standard on January 1, 2021 did not have a material impact on the Company’s consolidated financial statements.
Accounting Standards Issued But Not Yet Adopted
ASU 2020-04, “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” ASU 2020-04 provides optional expedients and exceptions for accounting related to contracts, hedging relationships and other transactions affected by reference rate reform if certain criteria are met. ASU 2020-04 applies only to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform and do not apply to contract modifications made and hedging relationships entered into or evaluated after December 31, 2022, except for hedging relationships existing as of December 31, 2022, that an entity has elected certain optional expedients for and that are retained through the end of the hedging relationship. ASU 2020-04 was effective upon issuance and generally can be applied through December 31, 2022. The adoption of this standard is not expected to have a significant impact on the Company’s consolidated financial statements.
8
Note 4 — Cash, Cash Equivalents, and Restricted Cash
The Company is required to hold cash for potential future advances due to certain borrowers. The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the Company’s consolidated statement of financial condition that sum to the total of the same such amounts shown in the consolidated statements of cash flows for the three months ended March 31, 2021 and 2020 (in thousands):
7,649
4,483
Total cash, cash equivalents, and restricted cash shown in the statement of cash flows
Note 5 — Loans Held for Sale, Net
The Company had no loans held for sale as of March 31, 2021 and the following table summarizes loans held for sale as of December 31, 2020 (in thousands):
Unpaid principal balance
12,929
Valuation adjustments
Deferred loan origination costs
194
Ending balance
Note 6 — Loans Held for Investment and Loans Held for Investment at Fair Value
The following tables summarize loans held for investment as of March 31, 2021 and December 31, 2020 (in thousands):
Total loans held for investment
1,989,316
1,990,684
Valuation adjustments on FVO loans
(4
25,070
2,014,386
2,015,750
Allowance for loan losses
(5,881
Total loans held for investment and loans held for investment at
fair value, net
1,930,334
1,541
1,931,875
23,600
1,953,934
1,955,473
(5,845
1,949,628
9
The following table presents the activity in the UPB and amortized cost basis of loans in the Company's COVID-19 forbearance program for the three months ended March 31, 2021 ($ in thousands):
UPB
%
Amortized Cost
Beginning balance
392,073
396,918
Additions
2,616
2,615
Foreclosures
(253
(260
Repayments
(30,697
(31,043
363,739
368,230
Performing/Accruing
289,441
79.6%
292,987
Nonperforming/Nonaccrual
74,298
20.4%
75,243
The following table presents the UPB and amortized cost basis of loans in the Company's COVID-19 forbearance program as of December 31, 2020 ($ in thousands):
327,708
83.6%
330,495
83.3%
64,365
16.4%
66,423
16.7%
Since the inception of the COVID-19 forbearance program, the Company has modified $404.1 million in UPB of loans, which includes capitalized interest of $8.6 million. As of March 31, 2021, $69.5 million in UPB of modified loans has been paid down, which includes $0.8 million of capitalized interest received.
Approximately 79.6% and 83.6% of the COVID forbearance loans in UPB were performing, and 20.4% and 16.4% were on nonaccrual status as of March 31, 2021 and December 31, 2020, respectively.
As of March 31, 2021 and December 31, 2020, the gross unpaid principal balance of loans held for investment pledged as collateral for the Company’s warehouse facility agreements, and securitizations issued were as follows (in thousands):
The 2013 repurchase agreement
118,134
91,074
The 2015 repurchase agreement
130,684
The Bank credit agreement
16,179
Total pledged loans
264,997
2014-1 Trust
20,908
22,228
2015-1 Trust
41,319
48,179
2016-1 Trust
65,319
71,271
2016-2 Trust
43,703
47,282
2017-1 Trust
72,511
81,376
2017-2 Trust
122,457
137,970
2018-1 Trust
99,928
112,042
2018-2 Trust
212,549
224,195
2019-1 Trust
190,478
203,144
2019-2 Trust
166,473
175,560
2019-3 Trust
128,144
135,527
2020-1 Trust
232,008
241,664
2020-2 Trust
121,216
123,646
2020-MC1 Trust
205,123
228,470
1,722,136
1,852,554
Nonaccrual Loans
The following tables present the amortized cost basis, or recorded investment, of the Company’s loans held for investment that were nonperforming and on nonaccrual status as of March 31, 2021 and December 31, 2020, and accruing loans that were 90 days or more past due as of March 31, 2021 and December 31, 2020. These accruing loans that were 90 or more days past due represent loans that were granted a forbearance under the Company’s COVID-19 payment forbearance programs.
Nonaccrual
Nonaccrual with No Allowance for Loan Loss
Nonaccrual with Allowance for Loan Loss
Allowance for Loans Individually Evaluated
% of Allowance to Total Nonaccrual/ Impaired Loans
Loans 90+ DPD Still Accruing COVID-19 Program
Commercial - Purchase
22,241
20,899
1,342
116
0.4
Commercial - Refinance
103,778
97,971
5,807
570
2.2
Residential 1-4 Unit - Purchase
21,857
21,600
257
96
Residential 1-4 Unit - Refinance
127,106
118,766
8,340
525
2.0
156
Quick Fix 1-4 Unit - Purchase
4,345
3,050
1,295
323
1.2
Quick Fix 1-4 Unit - Refinance
59,434
50,264
9,170
1,347
5.1
338,761
312,550
26,211
2,977
11.4
Troubled Debt Restructuring included
in nonaccrual loans:
171
25
22,166
20,955
1,211
153
0.7
101,117
96,804
4,313
519
2.3
26,373
25,839
534
128
0.6
120,152
113,206
6,946
465
2.1
109
6,585
3,808
2,777
2.4
59,843
53,616
6,227
878
4.0
123
336,236
314,228
22,008
2,668
12.1
1,979
173
The Company has made the accounting policy election not to measure an allowance for credit losses for accrued interest receivables. The Company has also made the accounting policy election to write off accrued interest receivables by reversing interest income when loans are placed on nonaccrual status, or 90 days or more past due, other than the COVID-19 forbearance-granted loans.
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.
11
The following table presents the amortized cost basis in the loans held for investment, excluding loans held for investment at fair value, as of March 31, 2021 and 2020, and the amount of accrued interest receivables written off by reversing interest income by portfolio segment for the three months ended March 31, 2021 and 2020 (in thousands):
Interest Reversal
326,082
(140
313,856
(123
693,247
(468
728,917
(672
239,201
(58
255,842
(83
598,744
(521
627,104
(612
40,739
(46
116,373
(242
(1,475
1,925,719
(1,490
For the three months ended March 31, 2021 and 2020, cash basis interest income recognized on nonaccrual loans was $6.7 million and $3.3 million, respectively. Interest income recognized on loans 90 days or more past due and still accruing for the three months ended March 31, 2021 was $5.0 thousand. No accrued interest income was recognized on nonaccrual loans for the three months ended March 31, 2020. The average recorded investment of individually evaluated loans, computed using month-end balances, was $337.1 million and $142.7 million for three months ended March 31, 2021 and 2020, respectively. There were no commitments to lend additional funds to debtors whose loans have been modified as of March 31, 2021 and 2020.
Allowance for Credit Losses
The allowance for credit losses is maintained at a level deemed adequate by management to provide for expected losses in the portfolio at the balance sheet date. The allowance for credit losses is measured using two components. A component that measures expected credit losses on a collective (pool) basis when similar risk characteristics exist and a component that measures expected credit losses on an individual loan basis. To estimate the allowance for credit losses in the loans held for investment portfolio, management follows a detailed internal process, considering a number of different factors including, but not limited to, the 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 Company uses an open pool loss rate methodology to model expected credit losses on a collective basis. To determine the loss rates for the open pool method, the Company starts with its historical database of losses, segmenting the loans by loan purpose, product type and repayment period. A third-party model applying the open pool method is used to estimate an annual average loss rates by dividing the respective pool's quarterly historical losses by the pool's respective prior quarter’s ending unamortized loan cost balance and deriving an annual average loss rate from the historical quarterly loss rates. The model then adjusts the annual average loss rates based upon macroeconomic forecasts over a reasonable and supportable period, followed by a straight-line reversion to the historical loss rates. The adjusted annual average loss rates are applied to the forecasted pool balance within each segment. The forecasted balances in the loan pool segments are calculated based on a principal amortization using contractual maturity, factoring in further principal reductions from estimated prepayments. For the March 31, 2021 estimate, the Company considered a COVID-19 adverse stress scenario and a COVID-19 severe stress scenario, both with a five-quarter reasonable and supportable forecast period followed by a four-quarter straight-line reversion period. Management concluded that applying a 50% weight to the adverse stress scenario and a 50% weight to the severe stress scenario, was appropriate given the status of the pandemic at the end of March 2021.
Once a loan becomes nonperforming (90 or more days past due), it no longer shares the same risk characteristics of the other loans within its segment of homogeneous loans (pool). Nonperforming loans are considered collateral dependent by the Company. These loans are evaluated individually using the practical expedient to determine the credit exposure.
The following tables present the activity in the allowance for credit losses for the three months ended March 31, 2021 and 2020 (in thousands):
Three Months Ended March 31, 2021
Residential
Quick Fix
Commercial
1-4 Unit
Purchase
Refinance
Allowance for credit losses:
Balance - January 1, 2021
373
2,093
333
1,216
595
1,235
5,845
Provision for loan losses (1)
(103
26
(195
411
Charge-offs
(37
(14
(18
(69
328
1,990
322
1,227
386
1,646
5,881
Allowance related to:
Loans individually evaluated
Loans collectively evaluated
212
1,419
703
63
281
2,904
Amortized cost related to:
303,841
589,469
217,344
471,638
36,394
56,939
1,675,625
Three Months Ended March 31, 2020
Beginning balance, prior to adoption of ASC 326
304
1,016
148
772
2,240
Impact of adopting ASC 326
19
62
47
137
1,078
157
819
2,377
108
516
493
(79
(80
(12
(171
352
1,594
250
1,300
3,496
130
479
842
215
1,464
154
821
2,654
11,436
60,205
13,266
66,737
151,644
302,419
668,712
242,577
560,367
1,774,075
The provision for loan losses decreased from approximately $1.3 million for the three months ended March 31, 2020 to $0.1 million for the three months ended March 31, 2021 due to an improved economic outlook as the economy recovers from the COVID-19 pandemic.
Credit Quality Indicator
A credit quality indicator is a statistic used by the Company to monitor and assess the credit quality of loans held for investment, excluding loans held for investment at fair value. The Company monitors its charge-off rate in relation to its nonperforming loans as its credit quality indicator. Nonperforming loans are loans that are 90 or more days past due, in bankruptcy, in foreclosure, or not accruing interest. As of March 31, 2021, the annualized charge-off rate was 0.08% of average nonperforming loans. The charged-off rate was 0.65% for the year ended December 31, 2020.
13
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, excluding loans held for investment at fair value, which includes $368.2 million and $396.9 million loans in the Company’s COVID-19 forbearance program as of March 31, 2021 and December 31, 2020, respectively (in thousands):
30–59 days
60–89 days
90+days
past due
past due(1)
Current
loans
1,634
1,266
19,341
2,490
3,541
97,576
103,607
684
1,445
19,728
965
4,300
121,841
338
3,908
606
858
57,970
Total loans individually evaluated
6,717
11,509
320,364
338,590
10,601
3,931
14,532
289,309
25,076
14,149
39,225
550,244
2,132
2,306
4,438
212,906
24,404
11,312
35,872
435,766
813
25,488
26,301
10,093
4,656
2,961
7,617
49,322
Total loans collectively evaluated
67,682
60,147
127,985
1,547,640
74,399
71,656
320,520
466,575
1,547,811
961
1,307
19,898
2,118
7,532
91,467
192
2,915
23,266
1,440
3,010
115,702
964
760
58,119
5,675
15,524
315,037
8,000
7,081
15,081
263,657
278,738
33,725
13,224
48,696
535,285
583,981
5,030
1,261
6,291
191,928
198,219
33,144
14,567
47,820
398,953
446,773
1,972
21,780
23,752
12,987
36,739
8,406
5,383
13,912
59,336
73,248
90,277
63,296
155,552
1,462,146
1,617,698
95,952
78,820
317,016
491,788
Includes loans in bankruptcy and foreclosure less than 90 days past due
14
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 March 31, 2021 and December 31, 2020 (in thousands).
Term Loans Amortized Cost Basis by Origination Year
March 31, 2021:
2019
2018
2017
Pre-2017
Payment performance
Performing
39,244
54,390
98,003
62,197
28,679
21,328
Nonperforming
2,433
4,544
6,125
6,878
2,261
Total Commercial - Purchase
56,823
102,547
68,322
35,557
23,589
46,383
72,873
163,411
149,717
76,343
80,742
6,649
32,110
31,368
18,123
15,528
Total Commercial - Refinance
79,522
195,521
181,085
94,466
96,270
46,051
13,776
64,411
40,308
22,829
29,969
5,783
5,453
3,568
4,570
Total Residential 1-4
Unit - Purchase
16,259
70,194
45,761
26,397
34,539
85,491
37,453
151,229
91,567
49,775
56,123
7,737
45,113
37,548
20,347
16,361
45,190
196,342
129,115
70,122
72,484
21,813
14,395
186
1,801
2,128
416
Total Quick Fix 1-4
23,614
16,523
602
28,366
28,573
16,706
35,041
7,687
Unit - Refinance
45,072
63,614
Total Portfolio
217,169
266,480
644,741
432,572
226,542
226,882
15
2016
Pre-2016
56,446
99,534
64,706
34,862
9,500
13,690
1,046
4,666
5,799
7,182
1,934
57,492
104,200
70,505
42,044
11,039
15,624
300,904
75,376
176,854
157,499
87,476
34,858
51,918
4,929
26,776
32,955
18,980
10,392
7,085
80,305
203,630
190,454
106,456
45,250
59,003
685,098
26,215
69,775
42,537
25,874
7,056
26,762
1,611
5,973
8,949
5,059
1,348
3,433
27,826
75,748
51,486
30,933
8,404
30,195
224,592
57,945
168,912
96,568
61,033
22,949
39,366
3,934
42,159
37,451
17,942
7,653
11,013
61,879
211,071
134,019
78,975
30,602
50,379
566,925
20,563
15,990
3,764
2,217
604
24,327
18,207
790
43,324
35,234
37,818
196
17,318
33,711
8,719
95
52,552
71,529
8,915
133,091
304,381
684,385
456,169
258,503
95,295
155,201
Note 7 — Securitizations, Net
From May 2011 through March 2021, the Company completed fifteen securitizations of $3.4 billion of loans, issuing $3.1 billion of securities to third parties through fifteen respective Trusts. The Company is the sole beneficial interest holder of the remaining Trusts, which are variable interest entities included in the consolidated financial statements. The transactions are accounted for as secured borrowings under U.S. GAAP. The securities are subject to redemption by the Company when the stated principal balance is less than a certain percentage, ranging from 5%–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 September 2044 through July 2050.
16
The following table summarizes the outstanding balance, net of discounts and deals costs, of the securities and the effective interest rate for the three months ended March 31, 2021 and 2020 (dollars in thousands):
Securitizations:
1,576,432
Interest expense
19,127
18,547
Average outstanding balance
1,548,642
1,542,318
Effective interest rate (1)
4.94
4.81
Represents annualized interest expense divided by average gross outstanding balance and includes average rate (4.24%) and debt issuance cost amortization (0.70%) and average rate (4.26%) and debt issuance cost amortization (0.55%) for the three months ended March 31, 2021 and 2020, respectively.
Note 8 — Other Debt
The secured financing and warehouse facilities were utilized to finance the origination and purchase of commercial real estate mortgage loans. Warehouse facilities are designated to fund mortgage loans that are purchased and originated within specified underwriting guidelines. These lines of credit fund less than 100% of the principal balance of the mortgage loans originated and purchased, requiring the use of working capital to fund the remaining portion.
Secured Financing, Net (Corporate Debt)
On February 5, 2021, the Company entered into a five-year $175.0 million syndicated corporate debt agreement, the (“2021 Term Loan”). The 2021 Term Loan bears interest at a rate equal to one-month LIBOR plus 8.00% with a 1.00% LIBOR floor, and matures on February 4, 2026. The 2021 Term Loan provides for an initial loan of $125.0 million and a delayed draw commitment of $50.0 million. On March 24, 2021, the Company received a first advance of $15.0 million of the delayed draw commitment. On April 21, 2021, the Company received the remaining $35.0 million under the delayed draw commitment. The principal of the 2021 Term Loan amortizes quarterly at an annual rate of 2.50% for the first year and 5.00% per year thereafter. A portion of the net proceeds from the 2021 Term Loan was used to redeem all the amounts owing pursuant to the 2019 debt agreement (“2019 Term Loan”). The remaining portion of the net proceeds from the 2021 Term Loan has and will be used for loan originations and general corporate purposes.
As of March 31, 2021, the balance of the 2021 Term Loan was $139.1 million. The balance of the 2019 Term Loan was $78.0 million as of December 31, 2020. The balances in the consolidated Balance Sheets are net of debt issuance costs and discounts of $9.5 million and $3.0 million as of March 31, 2021 and December 31, 2020, respectively. The 2021 Term Loan is secured by substantially all assets of the Company not otherwise pledged under a securitization or warehouse facility and contains certain reporting and financial covenants. Should the Company fail to adhere to those covenants, the lenders have the right to demand immediate repayment that may require the Company to sell the collateral at less than the carrying amounts. As of March 31, 2021, the Company was in compliance with these covenants.
Warehouse Repurchase and Revolving Loan Facilities, Net
On May 17, 2013, the Company entered into a Repurchase Agreement (“the 2013 Repurchase Agreement”) with a warehouse lender. The 2013 Repurchase Agreement has a current maturity date of September 29, 2021, and is a short-term borrowing facility, collateralized by a pool of performing loans, with a maximum capacity of $100.0 million, and bears interest at one-month LIBOR plus 3.25%. All borrower payments on loans financed under the warehouse repurchase facility are first used to pay interest on the facility.
On September 12, 2018, the Company entered into a three-year 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, 2023. During the borrowing period, the Company can take loan advances from time to time subject to availability. Each loan advance bears interest at the lesser of the one-month LIBOR Rate with a 0.75% floor, plus 3.5% per annum and the maximum rate, which is the highest lawful and non-usurious rate of interest applicable to the loan. The maximum capacity under this facility is $50.0 million. Borrowings under this warehouse agreement was $12.1 million and zero as of March 31, 2021 and December 31, 2020, respectively.
On December 26, 2019, the Company entered into a $3.0 million loan agreement (“the 2019 Loan”) with a lender. The 2019 Loan is secured by five real properties acquired by the Company through foreclosure or by deed-in lieu of foreclosure. The 2019 Loan bears a fixed interest rate of 9.5% with an extended maturity date of July 1, 2021.
On January 29, 2021, the Company entered into a non-mark-to-market Repurchase Agreement (“the 2021 Repurchase Agreement”) with a warehouse lender. The 2021 Repurchase Agreement has a maturity date of January 29, 2022, and was a short-term borrowing facility, collateralized by a pool of loans, with a maximum capacity of $200.0 million, and bore interest at one-month LIBOR plus a margin of 3.50% during the availability period and 4.50% during the amortization period. All borrower payments on loans financed under the warehouse repurchase facility are first used to pay interest on the facility.
17
Certain of the Company’s loans are pledged as security under the warehouse repurchase facilities and the revolving loan facility, which contain covenants. Should the Company fail to adhere to those covenants or otherwise default under the facilities, the lenders have the right to terminate the facilities and demand immediate repayment that may require the Company to sell the collateral at less than the carrying amounts. As of March 31, 2021 and December 31, 2020, the Company was in compliance with these 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 March 31, 2021 and December 31, 2020 (in thousands):
Period end
balance (1)
Maximum
borrowing
capacity
The 2021 repurchase agreement
95,540
200,000
94,199
100,000
73,502
12,136
50,000
The 2019 loan agreement
2,700
3,000
Warehouse repurchase facilities amounts in the consolidated balance sheets are net of debt issuance costs amounting to $1.3 million and $0.3 million as of March 31, 2021 and December 31, 2020, respectively.
The following table provides an overview of the activity and effective interest rate for the three months ended March 31, 2021 and 2020 (dollars in thousands):
Warehouse and repurchase facilities:
113,528
347,350
Highest outstanding balance at any month-end
204,574
439,547
6.01
4.95
Represents annualized interest expense divided by average gross outstanding balance and includes average rate (4.77%) and debt issuance cost amortization (1.24%) and average rate (4.63%) and debt issuance cost amortization (0.32%) for the three months ended March 31, 2021 and 2020, respectively. The debt issuance cost amortization was higher for the three months ended March 31, 2021 as a result of a lower average outstanding borrowing balance from a new financing facility.
The following table provides a summary of interest expense that includes debt issuance cost amortization, interest, amortization of discount, and deal cost amortization for the three months ended March 31, 2021 and 2020 (in thousands):
Warehouse and repurchase facilities
1,705
4,301
Securitizations
(2)
Total interest expense
28,182
29,190
Included in the $7.4 million of interest expense – corporate debt for the three months ended March 31, 2021 was the one-time debt issuance costs write-off of $2.9 million and prepayment fee of $1.6 million associated with the payoff of $78.0 million in outstanding principal amount in February 2021.
Included in the $6.3 million of interest expense – corporate debt for the three months ended March 31, 2020 was the one-time debt issuance costs write-off of $3.5 million and prepayment fee of $0.3 million associated with the repayment of $75.0 million in outstanding principal amount in January 2020.
Note 9 — Commitments and Contingencies
Repurchase Liability
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 March 31, 2021 and December 31, 2020, the balance of repurchase liability was $138 thousand and $139 thousand, respectively, and it is included in accounts payable and accrued expenses in the consolidated balance sheets.
18
The Company is a party to various legal proceedings in the normal course of business. The Company, after consultation with legal counsel, believes the disposition of all pending litigation will not have a material effect on the Company’s consolidated financial condition or results of operations.
Note 10 — Stock-Based Compensation
The Company’s 2020 Omnibus Incentive Plan, or the 2020 Plan, authorized grants of stock‑based compensation instruments to purchase or issue up to 1,520,000 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. 10,000 shares were forfeited in January 2020. 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 name executive officers at no cost to employees.
Stock-based awards vest ratably over a service period of three years from the date of the grant. Compensation expense related to 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. The Company recognized $0.5 million and $0.2 million compensation expense related to the outstanding stock options and unvested restricted stock awards granted to employees for the three months ended March 31, 2021 and 2020, 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 stock options and restricted stock awards totaled $5.0 million and $2.8 million as of March 31, 2021 and 2020, respectively.
Note 11 — 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 months ended March 31, 2021 and 2020:
(In thousands, except per share data)
Basic EPS:
Less: deemed dividends on preferred stock
Net income attributable to common stockholders
Less: undistributed earnings attributable to participating securities
Basic earnings per common share
Diluted EPS:
Add dilutive effects for assumed conversion of Series A preferred stock
11,688
Add dilutive effects for warrants
1,587
Add dilutive effects for stock options
Add dilutive effects of unvested restricted stock awards
Weighted average diluted common shares outstanding
Diluted income per common share
NA: Participating securities were issued subsequent to March 31, 2020.
The following table sets forth the number of shares excluded from the computation of diluted loss per share, as their inclusion would have been anti-dilutive (in thousands):
Shares underlying Series A Convertible Preferred Stock
Shares underlying warrants
Stock options
785
773
Unvested restricted stock awards
Share equivalents excluded from EPS
Note 12 — Convertible Preferred Stock
On April 7, 2020, the Company issued and sold in a private placement 45,000 newly issued shares of Series A Convertible Preferred Stock, par value $0.01 per share (the “Preferred”), at a price per share of $1,000, plus warrants (the “Warrants”) to purchase an aggregate of 3,013,125 shares of the Company’s common stock to funds affiliated with Snow Phipps and a fund affiliated with Pacific Investment Management Company LLC (TOBI). Snow Phipps and TOBI are considered affiliates and, therefore, are related parties to the Company. This offering resulted in net proceeds to the Company of $43.2 million. In connection with these transactions, the Company entered into a securities purchase agreement with Snow Phipps and TOBI granting TOBI the right to nominate an additional director to the Company’s board of directors for so long as TOBI and its permitted transferees meet certain ownership thresholds.
The Preferred ranks senior to the Company’s common stock with respect to the payment of dividends and distribution of assets upon liquidation, dissolution and winding up. It is entitled to receive any dividends or distributions paid in respect of the common stock on an as-converted basis and has no stated maturity and will remain outstanding indefinitely unless converted into common stock or repurchased by the Company. Holders of the Preferred will be entitled to vote, together with the holders of common stock, on an as-converted basis, subject to limitations of the rules of the New York Stock Exchange, on all matters submitted to a vote of the holders of common stock, and as a separate class as required by law. The holders of the Preferred will also have the right to elect two directors to the board of directors of the Company if the Company defaults under its obligation to repurchase the Preferred.
The Preferred has a liquidation preference equal to the greater of (i) $2,000 per share from April 7, 2020 through October 7, 2022, which amount increases ratably to $3,000 per share from October 8, 2022 through November 28, 2024 and to $3,000 per share from and after November 28, 2024 and (ii) the amount such holder would have received if the Preferred had converted into common stock immediately prior to such liquidation.
Each share of the Preferred is convertible at the option of the holder into the number of shares of common stock equal to then applicable conversion rate of $1,000 divided by the applicable conversion price plus cash in lieu of fractional shares, if any. The initial conversion price is $3.85 and is subject to customary antidilution adjustments.
Beginning on October 8, 2021, the Company has the option to force a conversion of the preferred stock to common stock, provided that the daily Volume Weighted Average Price (“VWAP”) for a share of VEL common stock is more than 200% of the $3.85 conversion price for at least 20 trading days, whether consecutive or not, in the period of 30 consecutive trading days, provided that the 20 trading days includes the final 5 trading days of the 30-trading day period.
Beginning on October 7, 2022, if not for the repurchase prohibition contained in the Company’s material indebtedness, and in no event later than November 28, 2024, holders of the Preferred have the option to cause the Company to repurchase all or a portion of such holder’s shares of Preferred, for an amount in cash equal to such share’s liquidation preference. If the Company defaults on its repurchase obligation, the holders of the Preferred have the right (until the repurchase price has been paid in full, in cash, or such the Preferred has been converted) to force a sale of the Company and the holders of the Preferred will have the right to elect two directors of the Company’s Board until such default is cured. The Company is also required to redeem the Preferred upon a change of control (as defined in the certificate of designation governing the Preferred).
The Warrants are exercisable at the warrantholder’s option at any time and from time to time, in whole or in part, until April 7, 2025 at an exercise price of $2.96 per share of common stock, with respect to 2,008,750 of the Warrants, and at an exercise price of $4.94 per share of common stock, with respect to 1,004,375 of the Warrants. The exercise price and the number of shares of common stock issuable upon exercise of the Warrants are subject to customary antidilution adjustments and certain issuances of common stock (or securities convertible into or exercisable for common stock) at a price (or having a conversion or exercise price) that is less than the then current exercise price. The Company is not required to affect an exercise of Warrants, if after giving effect to the issuance of common stock upon exercise of such Warrants such warrantholder together with its affiliates would beneficially own 49% or more of the Company’s outstanding common stock.
The Company determined that none of the features embedded in the Preferred were required to be accounted for separately as a derivative.
20
The Preferred is recorded as mezzanine equity (temporary equity) on the consolidated balance sheets because it is not mandatorily redeemable, but does contain a redemption feature at the option of the Preferred holders that is considered not solely within the Company’s control. At June 30, 2020, the Company recognized the Preferred maximum redemption value of $90.0 million, which is the maximum redemption value on the earliest redemption date based on a redemption value of $2,000 per share and 45,000 shares of Preferred. The recording of the Preferred maximum redemption value was treated as a deemed dividend and resulted in a $49.0 million charge to Shareholders’ Equity. The maximum redemption value of $90.0 million remains the same as of March 31, 2021.
Note 13 — 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:
•
Level 1 - Valuation is based on quoted prices for identical instruments traded in active markets.
Level 2 - Valuation is based on quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable and can be corroborated by market data.
Level 3 - Valuation is based on significant unobservable inputs for determining the fair value of assets or liabilities. These significant unobservable inputs reflect assumptions that market participants may use in pricing the assets or liabilities.
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
Loans held for investment are recorded at their outstanding principal balance, net of purchase discounts, deferred loan origination fees/costs, and allowance for credit losses.
The Company determined the fair value estimate of loans held for investment using a third-party loan valuation model, a Level 3 measurement. The significant unobservable inputs used in the fair value measurement of the Company’s mortgage loans held for investment are discount rates, prepayment speeds, loss severity, and default rates. Significant changes in any of those inputs could result in a significant change to the loans’ fair value measurement.
Collateral Dependent or Loans Individually Evaluated
Nonaccrual loans held for investment are evaluated individually and are recorded at fair value on a nonrecurring basis. 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.
21
Interest-Only Strips
The Company retains an interest-only strip on certain sales of held for sale loans. The interest-only strips are classified as trading securities under FASB ASC Topic 320, Investments-Debt Securities. The interest-only strips are measured based on their estimated fair values using a discounted cash flow model, a Level 3 measurement. Changes in fair value are reflected in income as they occur.
Loans Held for Investment, at Fair Value
The Company has elected to account for certain purchased distressed loans held for investment, at fair value (the FVO Loans) using FASB ASC Topic 825, Financial Instruments (ASC 825). The FVO loans are measured based on their estimated fair values. Management identified all of these loans to be accounted for at estimated fair value at the instrument level. Changes in fair value are reflected in income as they occur.
The Company uses a third-party loan valuation model to estimate the fair value at instrument level, a Level 3 measurement. The significant unobservable inputs used in the fair value measurement of the Company’s mortgage loans held for investment, at fair value are discount rate, property values, prepayment speeds, loss severity, and default rates. Significant changes in any of those inputs in isolation could result in a significant change to the loans’ fair value measurement.
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.
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.
Securitizations, Net
The fair value estimate of securities issued is determined by using estimated cash flows discounted at an appropriate market rate, a Level 3 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.
Fair Value Disclosures
The following tables present information on assets measured and recorded at fair value as of March 31, 2021 and December 31, 2020, by level, in the fair value hierarchy (in thousands):
Fair value measurements using
Total at
Level 1
Level 2
Level 3
fair value
Recurring fair value measurements:
Interest-only strips
125
Total recurring fair value measurements
1,489
Nonrecurring fair value measurements:
11,377
Individually evaluated loans requiring specific allowance, net
23,234
Total nonrecurring fair value measurements
34,611
36,100
22
238
1,777
Impaired loans requiring specific allowance, net
19,340
48,213
49,990
The following table presents gains and losses recognized on assets measured on a nonrecurring basis for the three months ended March 31, 2021 and 2020 (in thousands):
Gain (loss) on assets measured on a nonrecurring basis
(40
Real estate held for sale, net
(435
(568
(308
71
Total net loss
(726
(537
The following tables present the primary valuation techniques and unobservable inputs related to Level 3 assets as of March 31, 2021 and December 31, 2020 (dollars in thousands):
Asset category
Fair value
Primary
valuation
technique
Unobservable
input
Range
Weighted
average
Individually evaluated
loans requiring specific
allowance, net
Market comparables
Selling costs
8.0%
Loans held for investment,
at fair value
Discounted cash flow
Discount rate
6.2%
Collateral value (% of UPB)
94.0% to 104.0%
100.0%
Timing of resolution/payoff (months)
13 to 31
24
Prepayment rate
22.6% to 30.0%
Default rate
5.0% to 15.0%
12.0%
Loss severity rate
1.0%
15.0%
0 to 12
1.4
23
14 to 31
25.0
17.5% to 30.0%
Loans held for sale
31 to 34
32.0
0 to12
1.5
The following is a rollforward of loans that are measured at estimated fair value on a recurring basis for the periods indicated (in thousands):
2,960
Loans liquidated
(163
Principal paydowns
Total unrealized gain (loss) included in net income
2,987
The following is a rollforward of interest-only strips that are measured at estimated fair value on a recurring basis for the periods indicated (in thousands):
894
Interest-only strip additions
1,820
Interest-only strip write-offs
(113
(1,180
Total unrealized loss included in net income
1,534
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 March 31, 2021 and December 31, 2020, 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, interest-only strips, REO and FVO loans, which were measured using unobservable inputs, including appraisals and broker price opinions on the values of the underlying collateral. Individually evaluated loans requiring an allowance were carried at approximately $23.2 million and $19.3 million as of March 31, 2021 and December 31, 2020, net of specific allowance for credit losses of approximately $3.0 million and $2.7 million, respectively.
A financial instrument is cash, evidence of an ownership interest in an entity, or a contract that creates a contractual obligation or right to deliver or receive cash or another financial instrument from a second entity on potentially favorable terms. The methods and assumptions used in estimating the fair values of the Company’s financial instruments are described above.
The following tables present carrying amounts and estimated fair values of certain financial instruments as of the dates indicated (in thousands):
Carrying
Estimated
Value
Fair Value
Assets:
Cash
2,060,578
Liabilities:
139,125
Warehouse repurchase facilities, net
1,508,475
Accrued interest payable
5,687
2,003,301
Accrued interest receivable
78,000
1,616,222
5,503
Note 14 — Subsequent Events
On April 16, 2021, The Company entered into a Term Repurchase Agreement (“the 2021 Term Repurchase Agreement”) with a warehouse lender. The 2021 Term Repurchase Agreement has a maturity date of April 16, 2024, with a borrowing period through April 16, 2023. During the borrowing period, the Company can take loan advances from time to time subject to availability. Each loan advance bears interest at one-month LIBOR plus 3.0% per annum. The maximum capacity under this facility is $100.0 million.
On April 21, 2021, the Company received the remaining $35.0 million under the delayed draw commitment of the 2021 Term Loan.
The Company has evaluated events that have occurred subsequent to March 31, 2021 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.
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, 2020, 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 “Cautionary Note on 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 small 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 17 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. 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 March 31, 2021, has an average balance of approximately $335,000. As of March 31, 2021, our loan portfolio totaled $2.0 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 66.3%, and was concentrated in 1-4 unit residential rental loans, which we refer to as investor 1-4 loans, representing 49.5% of the UPB. For the three months ended March 31, 2021, the annualized yield on our total portfolio was 8.41%.
We fund our portfolio primarily through a combination of committed and uncommitted secured warehouse facilities, securitizations, corporate debt and equity. The securitization market is our primary source of long-term financing. We have successfully executed fifteen securitizations, resulting in a total of over $3.1 billion in gross debt proceeds from May 2011 through March 2021.
We may also 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 securitizations and excludes our corporate debt. For the three months ended March 31, 2021, our annualized portfolio related net interest margin was 4.10%, an improvement of 3 basis points over the previous quarter. 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 months ended March 31, 2021, we generated pre-tax income and net income of $4.6 million and $3.4 million, respectively.
Items Affecting Comparability of Results
Due to a number of factors, our historical financial results may not be comparable, either from period to period, or to our financial results in future periods. We have summarized the key factors affecting the comparability of our financial results below.
In January 2020, we used $75.7 million of the net proceeds from our IPO to lower our interest expense through the repayment of $75.0 million outstanding principal amount on the 2019 Term Loan.
In late March 2020, we temporarily suspended our loan originations and purchases due to the business and economic uncertainties caused by the COVID-19 outbreak. In addition, effective May 1, 2020, we furloughed a significant number of our employees, mostly within our loan origination function.
On April 7, 2020, we issued and sold Preferred Stock and Warrants resulting in gross proceeds to us of $45.0 million.
In September 2020, we resumed loan originations and enhanced our loan operations processes during the temporary suspension, enabling us to streamline our operations by approximately 60 employees to be more cost effective going forward.
We fully paid off the remaining $78.0 million of the 2019 Term Loan in January 2021 with a portion of the net proceeds from the 2021 Term Loan.
Recent Developments
Strategies to Address Uncertainties Caused by COVID-19
The COVID-19 outbreak has caused significant disruption in business activity and the financial markets both globally and in the United States. As a result of the spread of COVID-19, economic uncertainties have arisen which negatively impacted our financial condition, results of operations and cash flows. The extent of the impact of COVID-19 on our operational and financial performance will depend on certain developments, including the duration and spread of the outbreak and impact on our customers, employees and vendors, impact of the new mutant strain of the virus, and the long-term success of the vaccines, all of which are uncertain at this time and cannot be predicted. The full extent to which COVID-19 may continue to impact our financial condition or results of operations cannot be reasonably estimated at this time.
During 2020 and the three months ended March 31, 2021, we proactively executed a number of business initiatives to strengthen our liquidity position and re-focus our business strategies in light of the effects of the COVID-19 pandemic, including the following:
In order to protect our employees, we have been working remotely since late March 2020. In addition, we have implemented COVID-19-related protective measures and protocols and allowed a limited number of staff to work from certain offices located across the country.
We strengthened our liquidity by obtaining a new corporate credit facility of $175.0 million on February 5, 2021. A portion of the proceeds were used to pay off existing corporate debt and the remainder will be used to grow our portfolio.
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 of 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, 2020 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:
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Net Interest Income
Net interest income is the largest contributor to our net income and is monitored on both an absolute basis and relative to provisions for loan losses and operating expenses. We generate net interest income to the extent that the rate at which we lend in our portfolio exceeds the cost of financing our portfolio, which we primarily achieve through long-term securitizations. Accordingly, we closely monitor the financing markets and maintain consistent dialogue with investors and financial institutions as we evaluate our financing sources and cost of funds.
To evaluate net interest income, we measure and monitor: (1) the yields on our loans, (2) the costs of our funding sources, (3) our net interest spread and (4) our net interest margin. Net interest spread measures the difference between the rates earned on our loans and the rates paid on our funding sources. Net interest margin measures the difference between our annualized interest income and annualized interest expense, or net interest income, as a percentage of average loans outstanding over the specified time period.
Periodic changes in net interest income are primarily driven by: (1) origination volume and changes in average outstanding loan balances and (2) interest rates and changes in interest earned on our portfolio or paid on our debt. Historically, origination volume and portfolio size have been the largest contributors to the growth in our net interest income. We measure net interest income before and after interest expense related to our corporate debt and before and after our provisions for loan losses.
Credit Losses
We strive to minimize actual credit losses through our rigorous screening and underwriting process and life of loan portfolio management and special servicing practices. We closely monitor the credit performance of our loan portfolio, including delinquency rates and expected and actual credit losses, as a key factor in assessing our overall business performance.
Operating Expenses
We incur operating expenses from compensation and benefits related to our employee base, rent and other occupancy costs associated with our leased facilities, our third-party primary loan servicing vendors, professional fees to the extent we utilize third-party legal, consulting and advisory firms, and costs associated with the resolution and disposition of real estate owned, among other items. We monitor and strive to prudently manage operating expenses and to balance current period profitability with investment in the continued development of our platform. Because volume and portfolio size determine the magnitude of the impact of each of the above factors on our earnings, we also closely monitor origination volume along with all key terms of new loan originations, such as interest rates, loan-to-value ratios, estimated credit losses and expected duration.
Factors Affecting Our Results of Operations
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, 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 the current disruption caused by the COVID-19 pandemic, macroeconomic conditions and market fundamentals, which can 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 securitizations, corporate debt and equity. We believe we have an established brand in the term securitization market and that this market will continue to support our portfolio growth with long-term financing. Changes in macroeconomic conditions can adversely impact our ability to issue securitizations and, thereby, limit our options for long-term financing. In consideration of this potential risk, we have entered into a credit facility for longer-term financing that will provide us with capital resources to fund loan growth in the event we are not able to issue securitizations.
29
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.
Portfolio and Asset Quality
Key Portfolio Statistics
March 31, 2020
Total loans
1,944,804
2,126,899
Loan count
5,935
5,878
6,504
Average loan balance
335
331
327
Weighted average loan-to-value
66.3
66.1
65.9
Weighted average coupon
8.42
8.51
8.61
Nonperforming loans (UPB)
335,048
(A)
332,813
186,362
Nonperforming loans (% of total)
16.83
17.11
8.76
Reflects the UPB of loans 90 days or more past due or placed on nonaccrual status. Includes $74.3 million of COVID-19 forbearance-granted loans placed on nonaccrual status as of March 31, 2021.
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 Loan-to-Value. Loan-to-value, or LTV, reflects the ratio of the original loan amount to the appraised value of the underlying property at the time of origination. In instances where the LTV at origination is not available for an acquired loan, the LTV reflects our best estimate of value at the time of acquisition. Weighted average LTV is calculated for the population of loans outstanding at the end of each specified period using the original loan amounts and appraised LTVs at the time of origination of each loan. LTV is a key statistic because requiring the borrower to invest more equity in the collateral minimizes our exposure for future credit losses.
Nonperforming Loans. Loans that are 90 or more days past due, except for certain loans in our COVID-19 forbearance program, in bankruptcy, in foreclosure, or not accruing interest are considered nonperforming loans. The dollar amount of nonperforming loans presented in the table above reflects the UPB of all loans that meet this definition. In the last 7 years, over 90% of our resolved nonperforming loans have either paid current or fully paid off, resulting in a complete recapture of all contractual principal and interest and, in many cases, additional default interest and prepayment fees.
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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
Average
Loan Size
Coupon
LTV
Three Months Ended March 31, 2021:
Loan originations — held for investment
233,041
377
7.44
68.5
Loan originations — held for sale
(—
)%
Total loan originations
Loan acquisitions — held for investment
Total loans originated and acquired
Three Months Ended December 31, 2020:
505
179,308
355
7.56
68.7
Three Months Ended March 31, 2020:
431
151,412
351
8.28
67.2
316
96,223
305
9.75
68.2
747
247,635
332
8.84
67.6
3,467
1,156
6.50
73.6
750
251,102
8.81
67.7
During the first quarter of 2021, we originated $233.0 million of loans, which was an increase of $53.8 million, or 22.4% from the quarter ended December 31, 2020, and a decrease of $14.6 million, or 5.9%, from $247.6 million from the quarter ended March 31, 2020.
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 financial statements as loans held for investment, net, and loans held for investment at fair value, which are presented in the financial statements 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:
1,902,566
(399
26,801
Total loans held for investment, gross
1,928,968
Allowance for credit losses
(3,496
1,925,472
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
146,142
7.3
100,025
5.2
2,163
0.1
Loans due in one to five years
13,717
79,398
4.1
2,921
0.2
Loans due in more than five years
1,830,825
92.0
1,752,452
90.7
1,897,482
99.7
100.0
31
Allowance for Loan Losses
For the March 31, 2021 CECL estimate, the Company considered a COVID-19 adverse stress scenario and a COVID-19 severe stress scenario, both with a five-quarter reasonable and supportable forecast period followed by a four-quarter straight-line reversion period. Management decided that using only the adverse stress scenario did not factor for the unknown impact and success of the COVID vaccine initiative and the accelerated reopening of schools and businesses. Management concluded that applying a 50% weight to the adverse stress scenario and a 50% weight to the severe stress scenario, was appropriate given the status of the pandemic at the end of March 2021. 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.
Our allowance for loan losses remained consistent as compared to December 31, 2020 and increased by $2.4 million to $5.9 million as of March 31, 2021, compared to $3.5 million as of March 31, 2020. The $2.4 million increase in allowance for credit losses was primarily attributable to the adverse business conditions caused by the COVID-19 pandemic assumed in our loan loss model projections and to the increase in our loan portfolio from March 31, 2020 to March 31, 2021. 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.
To estimate the allowance for credit losses in our loans held for investment portfolio, we follow a detailed internal process, considering a number of different factors including, but not limited to, our ongoing analyses of loans, historical loss rates, relevant environmental factors, relevant market research, trends in delinquencies, effects and changes in credit concentrations, and ongoing evaluation of fair values.
The following table illustrates the activity in our allowance for credit losses over the periods indicated:
Three Months Ended
5,748
406
(309
Total loans held for investment (UPB), excluding FVO (1)
1,899,179
Allowance for credit losses / loans held for investment, excluding FVO
0.30
0.18
Reflects the UPB of loans held for investment excluding loans held for investment at fair value (FVO). Loans held for investment, net on the consolidated balance sheets is net of allowance for credit losses of $5.9 million, and net deferred loan origination fees/costs of $25.1 million as of March 31, 2021.
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Credit Quality – Loans Held for Investment and Loans Held for Investment at Fair Value
The following table provides delinquency information on our loans held for investment and loans held for investment at fair value by UPB as of the dates indicated:
March 31, 2021 (A)
COVID-19
Forbearance
December 31, 2020 (A)
Performing/Accruing:
1,528,684
76.8
234,365
1,445,131
74.8
259,147
1,571,822
82.6
30-59 days past due
67,100
3.4
20,473
89,284
4.6
32,115
126,740
6.7
60-89 days past due
59,700
3.0
34,451
62,694
3.2
34,493
52,868
2.8
90+ days past due
152
0.0
1,953
Total Performing Loans
1,655,636
83.2
1,599,062
82.8
1,751,430
92.1
Nonperforming/Nonaccrual:
<90 days past due
18,076
0.9
3,426
20,778
1.1
727
11,600
72,303
3.6
29,314
82,004
4.2
34,120
42,529
Bankruptcy
15,226
0.8
3,126
12,655
1,650
9,463
0.5
In foreclosure
229,443
11.5
38,432
217,376
11.3
27,868
87,544
Total nonperforming loans
16.8
17.2
151,136
7.9
Balance includes $363.7 million UPB of loans held for investment as of March 31, 2021 and $392.1 million as of December 31, 2020 in our COVID-19 forbearance program.
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 $335.0 million or 16.8% of our held for investment loan portfolio as of March 31, 2021, compared to $332.8 million, or 17.2% as of December 31, 2020, and $151.1 million, or 7.9% of the held for investment loan portfolio as of March 31, 2020. The increase in total nonperforming loans as of March 31, 2021 was primarily attributed to the COVID-19 pandemic. 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.
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 table summarizes 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 $46.5 million and $16.4 million of non-performing loans during the quarter ended March 31, 2021 and March 31, 2020, respectively. Including REO resolutions, we realized net gains of $1.3 million and $0.7 million during the quarter ended March 31, 2021 and 2020, respectively. This is largely the result of collecting default interest and prepayment penalties in excess of the contractual interest due and collected.
The table below includes nonperforming loan resolutions for our long-term loans that did not receive a COVID-19 forbearance in 2020.
Long-Term Loans
Gain /
(Loss)
Resolved — paid in full
15,961
795
16,371
115
12,928
850
Resolved — paid current
10,774
13,414
880
3,504
101
Resolved — REO sold
2,754
76
237
69
1,091
(293
Total resolutions
29,489
933
30,022
1,064
17,523
658
Recovery rate on resolved
nonperforming UPB
103.2
103.5
103.8
33
The table below includes nonperforming loan resolutions for our short-term loans, now being held for investment, and also includes loans that were granted a COVID-19 forbearance in 2020. Prior to January 1, 2021, nonperforming loan resolutions presented only consisted of long-term nonperforming loans held for investment since the short-term loans, or loans with a maturity of two-year or less, were being held for sale until later in 2020. The short-term loans do not require prepayment fees and result in a lower gain when paid in full, as compared to long term loans.
Short-Term and Forbearance Loans
8,569
343
11,170
19,739
383
101.9
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.
Year Ended December 31,
Average nonperforming loans for the period (1)
333,239
246,972
102,567
1,600
579
Charge-offs / Average nonperforming loans for the period (1)
0.08
0.65
0.56
Reflects the monthly average of nonperforming loans held for investment during the period.
Reflects annualized year-to-date charge-offs to average nonperforming loans for the period.
Concentrations – Loans Held for Investment
As of March 31, 2021, our held for investment loan portfolio was concentrated in investor 1-4 loans, representing 49.5% of the UPB. Mixed used properties represented 13.8% of the UPB. No other property type represented more than 10.0% of our held for investment loan portfolio. By geography, the principal balance of our loans held for investment were concentrated 22.9% in New York, 22.5% in California, 12.4% in Florida, and 8.3% in New Jersey.
Property Type
% of Total UPB
Investor 1-4
3,511
984,845
49.5
Mixed use
718
275,036
13.8
Multifamily
183,163
9.2
Retail
412
177,655
8.9
Office
279
112,875
5.7
Warehouse
121,631
6.1
Other(1)
376
135,479
6.8
All other properties individually comprise less than 5.0% of the total unpaid principal balance.
Geography (State)
New York
941
449,021
22.9
California
904
455,777
22.5
Florida
839
246,462
12.4
New Jersey
631
164,812
8.3
2,620
674,612
33.9
All other states individually comprise less than 5.0% of the total unpaid principal balance.
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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. After foreclosure, we periodically obtain new valuations and any subsequent changes to fair value, less estimated costs to sell, are reflected as valuation adjustments.
As of March 31, 2021, our REO included 31 properties with a lower of cost or estimated fair value of $14.5 million compared to 35 properties with a lower of cost or estimated fair value of $15.8 million as of December 31, 2020.
Key Performance Metrics
March 31, 2021 (1)
December 31, 2020 (1)
March 31, 2020 (1)
Average loans
1,936,664
1,979,155
2,083,783
Portfolio yield
8.41
8.40
8.57
Average debt — portfolio related
1,662,170
1,726,245
1,889,668
Average debt — total company
1,770,535
1,804,245
1,984,136
Cost of funds — portfolio related
5.01
4.97
4.84
Cost of funds — total company
6.37
5.18
5.88
(3
Net interest margin — portfolio related
4.10
4.07
4.18
Net interest margin — total company
2.59
3.68
2.97
Charge-offs/Average loans held for investment
0.00
0.01
Pre-tax return on equity
8.27
21.82
6.62
Return on equity
6.10
17.78
4.58
Percentages are annualized.
Excluding the one-time debt issuance cost write-off of $2.9 million and prepayment penalties of $1.6 million associated with the $78.0 million payoff of our corporate debt in February 2021, key performance metrics for the three months ended March 31, 2021 are as follows: Costs of funds – total company 5.35%; Net interest margin – total company 3.52%; Pre-tax return on equity 16.36%; and Return on equity 12.07%.
(3)
Excluding the one-time debt issuance costs write-off of $3.5 million and prepayment penalties of $0.3 million associated with the $75.0 million paydown of our corporate debt in January 2020, key performance metrics for the three months ended March 31, 2020 are as follows: Cost of funds — total company 5.12%; Net interest margin — total company 3.69%; Pre-tax return on equity 13.32%; and Return on equity 9.22%.
Average Loans
Average loans reflects the daily average of total outstanding loans, including both loans held for investment and loans held for sale, as measured by UPB, over the specified time period.
Portfolio Yield
Portfolio yield is an annualized measure of the total interest income earned on our loan portfolio as a percentage of average loans over the given period. Interest income includes interest earned on performing loans, cash interest received on nonperforming loans, default interest and prepayment fees. 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 securitizations. 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
35
includes the amortization of expenses incurred in connection with our portfolio related financing activities and corporate debt. Through the issuance of long-term securitizations, we have been able to fix a significant portion of our borrowing costs over time. The strong credit performance on our securitizations has allowed us to issue debt at attractive rates.
Our portfolio related cost of funds increased to 5.01% for the three months ended March 31, 2021 from 4.97% for the three months ended December 31, 2020 and increased from 4.84% for the three months ended March 31, 2020.
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 increased slightly from 4.07% for the three months ended December 31, 2020 to 4.10% for the three months ended March 31, 2021 due to strong resolutions on nonperforming loans and a modest improvement in the nonaccrual rate. Portfolio related net interest margin decreased from 4.18% for the three months ended March 31, 2020 to 4.10% for the three months ended March 31, 2021 mainly as a result of increased nonperforming loans due to the COVID-19 pandemic and, to a lesser extent, the seasoning of our loan portfolio.
Our total company net interest margin decreased from 2.97% and 3.68% for the three months ended March 31, 2020 and December 31, 2020, respectively, to 2.59% for the three months ended March 31, 2021 as a result of expensing the unamortized debt issuance costs and prepayment fees associated with the payoff and paydown of the 2019 Term Loan in February 2021 and January 2020, respectively.
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
Income /
Yield /
Balance
Expense
Rate (1)
Loan portfolio:
8,904
20,719
202,474
Loans held for investment
1,927,760
1,958,436
1,881,309
41,557
Debt:
Warehouse facilities
(4)
60,065
717
4.77
1,666,180
20,726
4.98
Total debt - portfolio related
21,443
Corporate debt
108,365
27.13
(5)
1,900
9.74
94,468
26.85
(6
Total debt
23,343
Net interest spread -
portfolio related (2)
3.39
3.43
3.73
Net interest margin -
portfolio related
total company (3)
2.04
3.22
2.68
total company
Annualized.
Net interest spread — portfolio related is the difference between the rate earned on our loan portfolio and the interest rates paid on our portfolio-related debt.
Net interest spread — total company is the difference between the rate earned on our loan portfolio and the interest rates paid on our total debt.
The debt issuance cost amortization was higher for the three months ended March 31, 2021 as a result of a lower average outstanding borrowing balance from a new financing facility.
36
Excluding the one-time debt issuance cost write-off of $2.9 million and prepayment penalties of $1.6 million associated with the $78.0 million payoff of our corporate debt in February 2021, the corporate debt average rate would have been 10.49%; net interest spread — total company would have been 3.06%; and net interest margin — total company would have been 3.52% for the three months ended March 31, 2021.
(6)
Excluding the one-time debt issuance costs write-off of $3.5 million and prepayment penalties of $0.3 million associated with the $75.0 million paydown of our corporate debt in January 2020, the corporate debt average rate would have been 10.88%; net interest spread — total company would have been 3.44%; and net interest margin — total company would have been 3.69% for the three months ended March 31, 2020.
Charge-Offs
Our annualized charge-off rate for the three months ended March 31, 2021 decreased to 0.00% from 0.08% for the three months ended December 31, 2020. The annualized charge-off rate decreased from 0.01% for the three months ended March 31, 2020 to 0.00% for three months ended March 31, 2021. The decrease in the charge-off rate was primarily attributable to the minimal charge-offs incurred in the three months ended March 31, 2021. The charge-offs rate reflects year-to-date annualized charge-offs as a percentage of average loans held for investment for the respective quarter. We do not record charge-offs on our loans held for sale which are carried at the lower of cost or estimated fair value.
Pre-Tax Return on Equity and Return on Equity
Pre-tax return on equity and return on equity reflect income before income taxes and net income, respectively, as a percentage of the monthly average of stockholders/members’ equity over the specified time period.
March 31, 2021 (2)
March 31, 2020 (3)
Income before income taxes (A)
11,753
Net income (B)
9,576
Monthly average balance:
Stockholders' / Members' equity (C)
222,810
215,489
225,125
Pre-tax return on equity (A)/(C) (1)
21.8
6.6
Return on equity (B)/(C) (1)
17.8
Excluding the one-time debt issuance cost write-off of $2.9 million and prepayment penalties of $1.6 million associated with the $78.0 million payoff of our corporate debt in February 2021, income before income taxes would have been $9.1 million; net income would have been $6.7 million; pre-tax return on equity would have been 16.4%; and return on equity would have been 12.1% for the three months ended March 31, 2021.
Excluding the one-time debt issuance costs write-off of $3.5 million and prepayment penalties of $0.3 million associated with the $75.0 million repayment of our corporate debt in January 2020, income before income taxes would have been $7.5 million; net income would have been $5.2 million; pre-tax return on equity would have been 13.3%; and return on equity would have been 9.2% for the three months ended March 31, 2020.
Components of Results of Operations
Interest Income
We accrue interest on the UPB of our loans in accordance with the individual terms and conditions of each loan, discontinuing interest and reversing previously accrued interest once a loan becomes 90 days or more past due (nonaccrual status). When a loan is placed on nonaccrual status, the accrued and unpaid interest is reversed as a reduction to interest income and accrued interest receivable. Interest income is subsequently recognized only to the extent that cash payments are received or when the loan has returned to accrual status. Payments received on nonaccrual loans are first applied to interest due, then principal. Interest accrual resumes once a borrower has made all principal and interest payments due, bringing the loan back to current status.
Interest income on loans held for investment is comprised of interest income on loans and prepayment fees less the amortization of deferred net costs related to the origination of loans. Interest income on loans held for sale is comprised of interest income earned on loans prior to their sale. The net fees and costs associated with loans held for sale are deferred as part of the carrying value of the loan and recognized as a gain or loss on the sale of the loan.
Interest Expense — Portfolio Related
Portfolio related interest expense is incurred on the debt we incur to fund our loan origination and portfolio activities and consists of our warehouse facilities and securitizations. Portfolio related interest expense also includes the amortization of expenses incurred as a result of issuing the debt, which are amortized using the level yield method. Key drivers of interest expense include the debt amounts outstanding, interest rates, and the mix of our securitizations and warehouse liabilities.
37
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 2019 Term Loan and the 2021 Term Loan, as reflected on our consolidated balance sheets, and the related amortization of deferred debt issuance costs.
Net interest income represents the difference between portfolio related net interest income and interest expense on corporate debt.
Provision for Loan Losses
Effective January 1, 2020, we adopted ASU 2016-13 Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments replacing the incurred loss accounting approach with the current expected credit loss (CECL) approach. Under the CECL methodology, the allowance for credit losses is calculated using a third-party model with our historical loss rates by segment, loans position as of the balance sheet date, and assumptions from us.
Other Operating Income
Gain on Disposition of Loans. When we sell a loan held for sale, we record a gain or loss that reflects the difference between the proceeds received for the sale of the loans and their respective carrying values. The gain or loss that we ultimately realize on the sale of our loans held for sale is primarily determined by the terms of the originated loans, current market interest rates and the sales price of the loans. In addition, when we transfer a loan to REO, we record the REO at its fair value at the time of the transfer. The difference between the fair value of the real estate and the carrying value of the loan is recorded as a gain or loss. Lastly, when our acquired loans, which were purchased at a discount, pay off, we record a gain related to the write-off of the remaining purchase discount.
Unrealized Gain/(Loss) on Fair Value Loans. 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 as discussed more fully in the notes to our consolidated financial statements. 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 operations.
Other Income. Other income includes the following:
Unrealized Gains/(Losses) on Retained Interest Only Securities. As part of the proceeds received for the sale of our held for sale loans, we may receive an interest only security. Changes in fair value subsequent to initial recognition are reported as unrealized gains/(losses) on interest-only securities.
Valuation Allowance on Loans Held for Sale.Loans held for sale are carried at the lower of cost or estimated fair value. Adjustments to the carrying value of loans held for sale to estimate fair value are reported as valuation allowance.
Fee Income. In certain situations, we collect fee income by originating loans and realizing miscellaneous fees.
Compensation and Employee Benefits. Costs related to employee compensation, commissions and related employee benefits, such as health, retirement, and payroll taxes.
Rent and Occupancy. Costs related to occupying our locations, including rent, maintenance and property taxes.
Loan Servicing. Costs related to our third-party servicers.
Professional Fees. Costs related to professional services, such as external audits, legal fees, tax, compliance and outside consultants.
Real Estate Owned, Net. Costs related to our real estate owned, net, including gains/(losses) on disposition of REO, maintenance of REO properties, and taxes and insurance.
Other Operating Expenses. Other operating expenses consist of general and administrative costs such as, travel and entertainment, marketing, data processing, insurance and office equipment.
Provision for Income Taxes
The provision for income taxes consists of the current and deferred U.S. federal and state income taxes we expect to pay, currently and in future years, with respect to the net income for the year. The amount of the provision is derived by adjusting our reported net income with various permanent differences. The tax- adjusted net income amount is then multiplied by the applicable federal and state income tax rates to arrive at the provision for income taxes.
Consolidated Results of Operations
The following table summarizes our consolidated results of operations for the periods indicated:
$ Change
% Change
(3,930
(8.8
Interest expense - portfolio related
(2,016
Net interest income - portfolio related
(1,914
Interest expense - corporate debt
1,008
15.9
(2,922
(18.9
(1,185
(91.9
(1,737
(12.3
1,181
72.9
(1,433
(11.9
877
23.5
60
817
31.7
Portfolio related net interest income is the largest contributor to our net income. Our portfolio related net interest income decreased by $1.9 million from $21.8 million for the three months ended March 31, 2020 to $19.9 million for the three months ended March 31, 2021. The decrease was due to a decrease in our average loan balances from $2.1 billion for the three months ended March 31, 2020 to $1.9 billion for the three months ended March 31, 2021, and a decrease in the average loan yield from 8.57% to 8.41% over the same period, primarily attributable to an increase in nonperforming loans due to the pandemic.
Interest Income. Interest income decreased by $3.9 million to $40.7 million for the three months ended March 31, 2021, compared to $44.6 million for the three months ended March 31, 2020. The decrease is primarily attributable to a decrease in the average portfolio balance, which decreased $147.1 million from $2.1 billion for the three months ended March 31, 2020 to $1.9 billion for the three months ended March 31, 2021. The average yield over those same periods decreased from 8.57% to 8.41% mainly due to the increase in nonperforming loans due to the COVID-19 pandemic.
39
The following tables distinguish between the change in interest income attributable to change in volume and the change in interest income attributable to change in rate for the three months ended March 31, 2021 and December 31, 2020, and the three months ended March 31, 2021 and 2020, respectively. The effect of changes in volume is determined by multiplying the change in average loan balance by the previous period’s average yield. The effect of rate changes is calculated by multiplying the change in average yield by the current period’s average loan balance.
Three Months Ended March 31, 2021 and December 31, 2020
Loans
Income
Yield (1)
Three months ended March 31, 2021
Three months ended December 31, 2020
Volume variance
(42,491
(892
Rate variance
42
Total interest income variance
(850
(1) Annualized.
Three Months Ended March 31, 2021 and 2020
Three months ended March 31, 2020
(147,119
(3,151
(779
(0.16
Interest Expense — Portfolio Related. Portfolio related interest expense consists of interest incurred on our warehouse facilities and securitizations, which increased by 0.05% to 5.01% for the three months ended March 31, 2021 from 4.97% for the three months ended December 31, 2020, as a result of higher amortization expense resulting from faster prepayment speeds on more recent securitizations. The $2.0 million decrease from $22.8 million for the three months ended March 31, 2020 to $20.8 million for the three months ended March 31, 2021 was primarily attributable the decrease in our average debt which declined to $1.7 billion for the three months ended March 31, 2021 from $1.9 billion for the three months ended March 31, 2020.
The following tables present information regarding the portfolio related interest expense and distinguishes between the dollar amount of change in interest expense attributable to changes in the average outstanding debt balance (volume) versus changes in cost of funds (rate) for the three months ended March 31, 2021 and December 31, 2020, and the three months ended March 31, 2021 and 2020, respectively.
Debt (1)
Cost of
Funds (2)
(64,075
(796
185
0.05
Total interest expense variance
(611
(1) Includes securitizations and warehouse agreements.
(2) Annualized.
(227,498
(2,751
735
Net Interest Income After Provision for Loan Losses
Interest Expense — Corporate Debt. Corporate debt interest expense increased by $1.0 million from $6.3 million for the three months ended March 31, 2020 to $7.4 million for the three months ended March 31, 2021 primarily due to an increase in the corporate debt amount from $75.0 million as of March 31, 2020 to $140.0 million as of March 31, 2021.
Provision for Loan Losses. Our provision for loan losses decreased from $1.3 million for the three months ended March 31, 2020 to $0.1 million for the three months ended March 31, 2021.
Total other operating income increased from $1.6 million for the three months ended March 31, 2020 to $2.8 million for the three months ended March 31, 2021. The $1.2 million increase was primarily attributable to the decrease in unrealized loss on our interest-only strips.
221
8.4
(47
(104.4
1,007
(96.5
Total operating expenses decreased by $1.4 million to $10.6 million for the three months ended March 31, 2021 from $12.1 million for three months ended March 31, 2020. The decrease was primarily attributable to the $0.7 million and $0.6 million decreases in professional fees and net expenses of real estate owned, respectively.
145
2.9
(371
(16.6
(651
(55.0
(55.1
3.1
Compensation and Employee Benefits. Compensation and employee benefits remained relatively flat at $5.2 million for the three months ended March 31, 2021, as compared to $5.0 million for the three months ended March 31, 2020.
Rent and Occupancy. Rent and occupancy expenses remained consistent at $0.5 million for the three months ended March 31, 2020 and the three months ended March 31, 2021.
Loan Servicing. Loan servicing expenses decreased from $2.2 million for the three months ended March 31, 2020 to $1.9 million the three months ended March 31, 2021 primarily due to the decrease in our total loan balance, and the decrease in other fees.
Professional Fees. Professional fees decreased from $1.2 million for the three months ended March 31, 2020 to $0.5 million for the three months ended March 31, 2021, mainly due to a reduction in costs associated with our 2020 IPO.
41
Net Expenses of Real Estate Owned. Net expenses of real estate owned decreased from $1.1 million for the three months ended March 31, 2020 to $0.5 million for the three months ended March 31, 2021, mainly due to lower valuation adjustments, and higher gains on sale and rental income.
Other Operating Expenses. Other operating expenses remained consistent at $2.0 million for the three months ended March 31, 2020 and at $2.1 million for the three months ended March 31, 2021.
Income Tax Expense. Income tax expense was $1.2 million and $1.1 million for the three months ended March 31, 2021 and 2020, respectively. Our consolidated effective tax rate as a percentage of pre-tax income was 26.2% and 30.8% for the three months ended March 31, 2021 and 2020, respectively. The effective tax rate for the three months ended March 31, 2021 was lower compared to the same period in 2020 due to a reserve established in 2020 for an uncertain tax position and the actual change in the uncertain tax position that increased the effective tax rate.
Quarterly Results of Operations
The following table sets forth certain financial information for each completed fiscal quarter since the quarter ended June 30, 2019. 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 tables set for our unaudited quarterly results for the periods indicated:
March 31,
December 31,
September 30,
June 30,
(unaudited)
41,556
41,374
39,755
44,124
40,379
36,884
21,442
22,347
21,189
22,689
21,827
20,324
20,114
19,027
18,566
21,435
18,552
16,560
Net interest margin - portfolio related
3.77
3.54
4.32
4.06
3.91
1,913
1,894
4,070
3,842
3,353
18,214
17,114
16,672
17,365
14,710
13,207
Net interest margin - total company
3.18
3.50
3.12
1,573
1,800
242
Net interest income after provision
for loan losses
17,808
15,541
14,872
17,123
14,372
12,995
Other operating income (expense)
4,691
1,349
(1,339
833
(212
308
10,746
11,865
10,908
9,814
8,484
8,324
5,025
2,625
8,142
5,676
4,979
2,177
1,544
484
1,796
1,444
3,481
2,141
5,182
3,880
3,535
Liquidity and Capital Resources
Sources and Uses of Liquidity
We fund our lending activities primarily through borrowings under our warehouse facilities, securitizations, other corporate-level debt, equity, debt securities, and net cash provided by operating activities to manage our business. We use cash to originate and acquire investor real estate loans, repay principal and interest on our borrowings, fund our operations and meet other general business needs.
Cash and Cash Equivalents
We had cash of $20.4 million and $7.6 million, excluding restricted cash of $6.8 million and $4.5 million as of March 31, 2021 and 2020, 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 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 three months ended March 31, 2021, our net cash provided by operating activities consisted mainly of $6.4 million add-back of noncash debt issuance discounts and costs amortization and net income of $3.4 million.
For the three months ended March 31, 2021, our net cash used in investing activities consisted mainly of $236.5 million in cash used to originate held for investment loans, partially offset by $124.2 million in cash received in payments on held for investment loans and $57.9 million in proceeds from sale of loans.
For the three months ended March 31, 2021, our net cash provided by financing activities consisted mainly of $196.6 million and $140.0 million in borrowings from our warehouse facilities and proceeds from secured financing, respectively. The cash generated was partially offset by payments we made of $78.9 million and $128.4 million on our corporate debt and securitizations issued, respectively.
During the three months ended March 31, 2021, we generated approximately $6.9 million of net cash and cash equivalents from operations, investing and financing activities. During the three months ended March 31, 2020, we used approximately $15.4 million of net cash and cash equivalents in operations, investing and financing activities.
Warehouse Facilities
As of March 31, 2021, we had three warehouse facilities to support our loan origination and acquisition facilities. Two agreements are one-year warehouse repurchase facilities and the other agreement is a three-year warehouse facility. The borrowings are collateralized by primarily performing loans, bearing interest at one-month LIBOR with a 0.75% floor plus a margin that ranges from 2.75% to 3.50%. Borrowing under these facilities was $201.8 million as of March 31, 2021. Borrowing under two previous facilities was $73.5 million as of December 31, 2020.
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.
43
All borrower payments on loans financed under the warehouse agreements 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 to interest expense. If we fail to meet any of the covenants or otherwise default under the facilities, the lenders have the right to terminate their facility and require immediate repayment, which may require us to sell our loans at less than optimal terms. As of March 31, 2021, we were in compliance with these covenants.
From May 2011 through March 2021, we have completed fifteen securitizations of $3.4 billion of investor real estate loans, issuing $3.1 billion in principal amount of securities to third parties through fifteen respective transactions. 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 summarizing the investor real estate loans securitized, securities issued, securities retained by us at the time of the securitization, and as of March 31, 2021 and December 31, 2020, and the stated maturity for each securitization. The securities are callable by us when the stated principal balance is less than a certain percentage, ranging from 5%—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.
Equity in Securities Retained as of
Trusts
Mortgage
Securities
Issued
Issuance
Date
Stated Maturity
2011-1 Trust (1)
74,898
61,042
13,856
August 2040
191,757
161,076
30,682
September 2044
312,829
285,457
27,372
15,523
15,522
July 2045
358,601
319,809
38,792
17,931
April 2046
190,255
166,853
23,402
9,514
October 2046
223,064
211,910
11,154
April 2047
258,528
245,601
12,927
5,438
6,232
October 2047
186,124
176,816
9,308
4,757
6,015
April 2048
324,198
307,988
16,210
8,991
9,762
October 2048
247,979
235,580
12,399
8,241
11,540
March 2049
217,921
207,020
10,901
7,901
9,728
July 2049
162,546
154,419
8,127
6,302
6,441
October 2049
261,859
248,700
13,159
13,085
February 2050
128,470
96,352
32,118
12,847
June 2050
275,956
179,371
96,585
101,130
98,260
July 2050
3,414,985
3,057,994
356,992
222,814
228,031
The Trust was collapsed in July 2019
44
The following table summarizes outstanding bond balances for each securitization as of March 31, 2021 and December 31, 2020:
21,690
23,391
36,966
50,940
57,963
38,953
45,195
65,728
72,190
114,517
129,478
88,754
102,063
192,240
200,451
173,216
181,579
148,834
158,199
122,072
127,045
208,269
220,052
106,343
109,832
116,241
137,794
1,474,559
1,602,198
As of March 31, 2021 and December 31, 2020, the weighted average rate on the securities and certificates for the Trusts were as follows:
7.92
7.46
6.88
7.20
8.06
7.78
7.07
6.63
5.69
5.31
3.40
3.42
4.12
4.04
4.53
4.48
4.11
4.01
3.48
3.29
3.26
2.84
2.83
4.54
4.55
4.50
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 securitization as long-term financing for our portfolio, and we do not plan to structure any securitizations as sales or utilize off-balance-sheet vehicles. We believe any financing of assets and/or securitizations we may undertake will be sufficient to fund our working capital requirements.
Secured Financing (Corporate Debt)
On February 5, 2021, the Company entered into a five-year $175.0 million syndicated corporate debt agreement, the (“2021 Term Loan”). The 2021 Term Loan bears interest at a rate equal to one-month LIBOR plus 8.00% with a 1.00% LIBOR floor, and matures on February 4, 2026. The 2021 Term Loan provides for an initial loan of $125.0 million and a delayed draw commitment of $50.0 million. The delayed draw availability is contingent upon the Company adding a fourth non-mark-to-market warehouse line. On March 24, 2021, the Company received a first advance of $15.0 million of the delayed draw commitment. On April 21, 2021, the Company received the remaining $35.0 million under the delayed draw commitment following the addition of a fourth non-mark-to-market warehouse line on April 16, 2021. The principal of the 2021 Term Loan amortizes quarterly at an annual rate of 2.50% for the first year and 5.00% per year thereafter. A portion of the net proceeds from the 2021 Term Loan was used to redeem all the outstanding 2019 Term Loan. The remaining portion of the net proceeds from the 2021 Term Loan will be used for loan originations and general corporate purposes.
Contractual Obligations and Commitments
In August 2019, we entered into a five-year $153.0 million corporate debt agreement. This 2019 Term Loan bore interest equal to one-month LIBOR plus 7.50% and was to mature in August 2024. A portion of the net proceeds from the 2019 Term Loan was used to redeem the 2014 Senior Secured Notes. Another portion of the net proceeds from 2019 Term Loan, together with cash on hand, was used to repurchase our outstanding Class C preferred units. As of December 31, 2020 and 2019, including paid-in-kind interest, the aggregate outstanding principal amount of the 2014 Senior Secured Notes was zero and $127.6 million, respectively. In January 2020, we paid down $75.0 million of the 2019 Term Loan with a portion of our IPO proceeds. As of December 31, 2020, the outstanding principal amount of the 2019 Term Loan was $78.0 million. On February 5, 2021, we entered into a five-year $175.0 million syndicated corporate debt agreement (“2021 Term Loan”). The 2021 Term Loan under this agreement bears interest at a rate equal to one-month LIBOR plus 8.00% with a 1.00% LIBOR floor, and matures on February 4, 2026. The 2021 Term Loan provided an initial $125.0 million of funds to us and contains a delayed draw feature allowing an additional draw of $50.0 million by February 5, 2022 provided we meet certain conditions. A portion of the net proceeds from the 2021 Term Loan was used to redeem all the outstanding 2019 Term Loan. The remaining portion of the net proceeds from the 2021 Term Loan will be used for loan originations and general corporate purposes.
Velocity Commercial Capital, LLC is the borrower of the 2021 Term Loan, which is secured by substantially all of the borrower’s non-warehoused assets, with a guarantee from Velocity Financial, Inc., that is secured by the equity interests of the borrower. The syndicated corporate debt agreement contains customary affirmative and negative covenants, including financial maintenance covenants and limitations on dividends by the borrower.
As of March 31, 2021, we maintained warehouse facilities to finance our investor real estate loans and had approximately $204.6 million in outstanding borrowings with $148.2 million of available capacity under our warehouse and repurchase facilities.
In the event we are required to pay the Preferred holders their liquidation preference due to a redemption, liquidation or change of control, we would be required to pay the liquidation preference which is equal to the greater of (i) $2,000 per share from April 5, 2020 through October 5, 2022, which amount increases ratably to $3,000 per share between October 6, 2022 and November 28, 2024 and to $3,000 per share from and after November 28, 2024 and (ii) the amount such Preferred holder would have received if the Preferred had converted into common stock immediately prior to a liquidation.
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.
46
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 the resumption of 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. 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:
the description of our business contained in our Annual Report on Form 10-K for the year ended December 31, 2020 and filed with the Securities and Exchange Commission (“SEC”) on March 17, 2021
the discussion of our analysis of financial condition and results of operations contained in this Quarterly Report under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations”
the notes to the consolidated financial statements contained in this Quarterly Report
cautionary statements we make in our public documents, reports and announcements
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.
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. We intend to defend ourselves vigorously against any pending or future judicial, regulatory or administrative claims or proceedings. Although occasional adverse decisions or settlements may occur, our management does not believe that the final disposition of any currently pending or threatened matter will have a material adverse effect on our business, financial position, results of operations or cash flows.
On January 25, 2021, the previously disclosed IPO-related class action lawsuit filed against us and certain of our directors, shareholders and underwriters was dismissed.
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.
Item 3. Defaults Upon Senior Securities.
Item 4. Mine Safety Disclosures.
Item 5. Other Information.
None.
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
Certificate of Conversion
8-K
001-39183
1/22/2020
Certificate of Incorporation of Velocity Financial, Inc.
3.3
Bylaws of Velocity Financial, Inc.
Certificate of Designation of Series A Convertible Preferred Stock of Velocity Financial, Inc.
4/7/2020
3.5
Omnibus Consent between the Company and holders of Series A Preferred Stock dated February 5, 2021
Form of Warrant to Purchase Common Stock
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
Velocity Financial, Inc. 2020 Omnibus Incentive Plan*
10.4
Form of Nonqualified Stock Option Award Notice and Agreement under the 2020 Omnibus Incentive Plan*
S-1/A
333-234250
10.6
1/6/2020
10.5
Form of Nonqualified Stock Option Award Notice and Agreement (Director Grant-IPO) under the 2020 Omnibus Incentive Plan*
10.7
Form of Nonqualified Stock Option Award Notice and Agreement (Executive Officer Grant-IPO) under the 2020 Omnibus Incentive Plan*
10.8
Form of Restricted Stock Unit Grant and Agreement (Director Grant) under the 2020 Omnibus Incentive Plan*
10.9
Form of Restricted Stock Unit Grant and Agreement (Standard Grant) under the 2020 Omnibus Incentive Plan*
10.10
Form of Restricted Stock Grant and Agreement under the 2020 Omnibus Incentive Plan*
10.11
Form of Officer and Director Indemnity Agreement*
10.37
11/6/2019
Registration Rights Agreement, dated as of April 7, 2020
31.1
Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of Principal Financial and Accounting 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 and Accounting Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002+
101.INS
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema Document
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
101.PRE
XBRL Taxonomy Extension Presentation Linkbase 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: May 6, 2021
By:
/s/ Christopher D. Farrar
Christopher D. Farrar
Chief Executive Officer
/s/ Mark R. Szczepaniak
Mark R. Szczepaniak
Chief Financial Officer