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spk04: Thank you for standing by, and welcome to Q4 2020 Impact Mortgage Holdings Earnings Conference Call. At this time, all participants are in a listen-only mode. After this speaker presentation, there will be a question and answer session. To ask a question, you will need to press star 1 on your telephone. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, Mr. Justin Marzo. Please go ahead.
spk05: Thank you. Good afternoon, everyone. Thank you for joining Impact Mortgage Holdings' year-end 2020 earnings call. During this call, we will make projections or other forward-looking statements in regards to, but not limited to, gap in taxable earnings, cash flows, interest risk and market risk exposure, mortgage production, and general market conditions. I would like to refer you to the business risk factors that are most recently filed, Form 10-K, under the Securities Exchange Act of 1934. These documents contain and identify important factors that could cause the actual results to differ materially from those contained in our projections or forward-looking statements. This presentation, including outlook and any guidance, is effective as of the date given, and we expressly disclaim any duty to update the information herein. We'd like to get started by introducing George Mandracina, Chairman and CEO of Impact Mortgage Holding.
spk06: Thank you, Justin. Paul Eichen, our CFO, and Tiffany Etzminger, our COO, will join me for prepared remarks. Justin will be back along with Tom Donatacci, our Chief of Staff, and Joe Joffrey and our General Counsel for the question and answer segment. When we met about a year ago for the company's 2019 year-end earnings call, March 13, 2020 to be exact, We reported strong year-over-year operating results and discussed momentum we had anticipated would accelerate as we invested in technology, product design, industry talent, and geographic expansion. We also noted that any enthusiasm for future prospects needed to be properly balanced and tempered by potential supply and distribution constraints and attendant liquidity risks associated with the then-current macroeconomic conditions. In fact, 2020 presented the company with the Extraordinary challenges, the result of unprecedented credit and interest rate shocks and global market dislocations in the first and second quarters of the year. The difficult but necessary decisions the company executed on during the first half of 2020 have been well documented for our frequent business updates and prior quarterly earnings calls. These actions to de-risk the balance sheet and to consciously protect liquidity often at the expense of book value, positioned the company to normalize origination activity in the second half of 2020. Today, we are pleased to announce a second consecutive quarter of positive operating results, with 2020 fourth quarter earnings of 3.3 million, 16 cents a share, following 2020 third quarter earnings of 4.4 million, or 21 cents a share. Core earnings are an alternative measure of results that senior management utilizes to gauge the company's performance. They isolate results from recurring business activities by adjusting for certain non-recurring items, such as changes in the fair value of long-term debt and trust assets, gain or loss on mortgage servicing rights, and other non-recurring legacy matters. This concept was first introduced in the beginning of 2019. The table is provided with our earnings release to enable variation analysis between prior periods. Generating core earnings of approximately $8 million in the second half of 2020 versus core losses of approximately $66 million in the first half of 2020 was hard fought and a remarkable turnaround for the company. We would like to express our gratitude to our board of directors, our stakeholders, and our capital partners for their steadfast support under the most difficult of circumstances. And I personally I want to extend my thanks to our senior management team and our valued employees for their dedication and tireless focus on the company, often while managing stresses over health, family, and societal concerns brought on by COVID-19. Collectively, our stakeholders enabled the company to navigate through the unprecedented global market dislocation we experienced last year. On this call, we would like to highlight some of the key accomplishments for the second half of 2020. including the relaunch of our origination businesses, creating a profitable run rate in our consumer direct channel, restarting non-QM originations in our third-party or TPO channel, and enhancing the company's liquidity by extending our convertible promissory note. The company announced the relaunch of our lending activities in late second quarter within our consumer direct channel, focused initially on GSC, FHA, and VA product. In the latter half of the fourth quarter of 2020, we expanded those offerings to include non-agency jumbo and non-QM, and also relaunched our TPO channel. The company generated originations in excess of $800 million in Q4 2020 versus $400 million in Q3 of 2020 and just $2 million in Q2 of 2020. The increase reflects our success in ramping the call center to target originations of at least $250 million per month and the reintroduction of a broader product set across all channels. These origination activities were the prime driver of positive core earnings in the second half of the year. The company was not immune from margin compression experienced by the industry in the fourth quarter. This normalization was anticipated as industry capacity expanded to meet demand. Paul Lichen will address this in his prepared remarks. We entered 2020 with strong momentum. having repositioned the company over the years to expand our core competency related to alternative products. During the first quarter of 2020, prior to the disruption caused by COVID-19, we originated 260 million in non-QM loans and were on pace to exceed our fourth quarter 2019 non-QM origination volume. As financial markets became dislocated in March of 2020, Liquidity tightened and credit spreads widened substantially, with particular focus on non-QM payment delinquency and forbearance risk. To protect against market valuation declines, the company had a significant portion of our non-QM portfolio hedged via mandatory forward commitments with investors. Some of these hedges were not honored, causing the company to restructure the sale of these assets at market levels significantly below that which the company would have received under the terms of the mandatory forwards. We ceased originating non-QM loans in the beginning of April 2020. In the fourth quarter of 2020, market conditions and external factors, while not fully normalized, had sufficiently stabilized to the extent that the company elected to re-engage its lending activities within the non-QM market segment. The re-emergence of the non-QM market has been defined by products that originated to more restrictive credit underwriting guidelines than pre-COVID and consistent with the company's historical historic credit philosophy. We believe the quality of our loans have been demonstrated by their performance through the recent crisis. In 2020, our non-QM originations had a weighted average FICO of 730, weighted average LTV ratio of 68, compared to 731 and 70%, respectively, in 2019. Since the company has exceptionally historically been an innovator with respect to the design and origination of alternative credit products, Non-QM is a core competency differentiator for the company. We look forward to participating in the reemergence of this sector. As discussed on prior calls, improving and protecting the firm's liquidity was a primary objective for the firm in 2020. In line with these objectives, on October 28, 2020, we announced an extension of our convertible promissory note. This agreement extended the maturity date of the note by an additional 18 months from November 9, 2020 to May 9, 2022, and reduced the aggregate principal amount of the note to $20 million following a paydown of $5 million in principal. The company's cash and unencumbered whole-loan position was approximately $60 million at the end of the fourth quarter. As compared to $65 million at the end of the third quarter, we believe this liquidity position provides a margin of safety to address future market volatility. Finally, I would like to note that November 20th, 2020 marked the 25th anniversary of our initial public offering, a tribute to the company's resilience in navigating numerous economic and political events. We remain optimistic about the future. The company continues to originate through our consumer direct and third-party channels and is well-positioned to take advantage of opportunities as the agency and alternative credit markets evolve. I'll now hand the call over to Paul Lyken. Paul?
spk08: Thanks, George. In Q4, we continued to successfully ramp up production. We increased our funding volume from $418 million in Q3 to $810 million in Q4, representing a 94% quarter-over-quarter increase. In addition, we grew our lock pipeline by 26% from $359 million at the end of Q3 to $451 million at the end of Q4. As George mentioned earlier, we continue to carefully manage our liquidity as evidenced by our cash position of $54 million at the end of the year, while also extending our convertible notes due in November of 2020 to May of 2022 at the same funding cost. Our enhanced liquidity position gives the company the flexibility to continue to increase production and invest capital for continued growth. The financial results of the quarter reflect increased loan production net of the effect of the market margin compression, Excluding the effects of quarter-end locked pipeline, we saw margin compression of approximately 73 bps in Q4 versus prior quarter. However, for some context, our Q4 2020 margins were around 80 basis points higher than our January and February 2020 margins pre-COVID. Gain on sale loans increased from 19.3 million in Q3 to 21.5 million in Q4. As a result of increasing production volumes, Total operating expenses increased from 16.1 million in Q3 to 19.9 million in Q4, led by an increase in personnel costs from 11.2 million in Q3 to 13.3 million in Q4. Under current production goals, we expect compensation expense to level off subject to market capacity constraints. Gap net loss before tax was 2.1 million in Q4 versus pre-tax income of 1.6 million in Q3. Core earnings were $3.3 million for Q4 versus $4.4 million in Q3. Our 2020 year-to-date gap net loss before tax was $88 million, while year-to-date core loss was $59 million, compared to 2019 year-to-date gap net loss of $8 million and core earnings of $16 million. Turning to liquidity, as of the end of Q4, we had $54 million in unstricted cash and $6 million in unencumbered loans on our balance sheet of which we expect to monetize and be additive to our cash balance, versus $55 million in unrestricted cash and $9 million in unencumbered loans at the end of Q3. In addition, we currently have warehouse lines with combined borrowing capacity of $550 million. During the quarter, our funding to settle turn times were in the low 20-day range. However, this remains subject to the risk of increased turn times and capacity constraints inherent in an aggregation execution model. However, based on our current cash position, turn times, and borrowing resources, we feel we have the liquidity necessary to meet our near-term production goals. I will now turn it over to Tiffany to discuss production mix and product focus.
spk01: Thank you, Paul. In the fourth quarter marked a steady increase in origination volume, reaching over $800 million in funded volume for the quarter and exceeding our $250 million monthly funding targets. We expanded our product offering to include QM jumbo and non-QM in the third and fourth quarters and received favorable market reception among consumers and brokers in both our retail and TPO channels. Our primary focus since the resumption of lending activity in the second quarter has been to originate GFC and government products. Margins have been historically high. Origination volume is undoubtedly higher in their diversified capital markets exits. the risk-based overlays imposed by many lenders began to dissipate in the fourth quarter, allowing for a more normalized credit underwrite under GFC guidelines. Impact adjusted its credit box in line with industry standards and accepted risk tolerances, which in turn contributed to increased originations during the fourth quarter. Talent retention and acquisition remained a relevant topic throughout the quarter. Impact focused not just on recruitment, but also on building a strong leadership infrastructure within its operating channels to support future growth and stability. Our employee headcount grew during the quarter to over 320 employees, up from 250 at the end of the second quarter, 2020, with the additional staff being added to retail and wholesale sales and operations groups. Ongoing wage inflation and increased personnel expense had an impact on our overall cost to originate. However, the talent hired and retained was essential to growing the channels and exceeding the $250 million targeted monthly run rate. Based on current models, we plan to maintain a run rate of at least $250 million through the first quarter of 2021. As predicted, we adjusted marketing spend throughout the quarter to support volume targets and drive new product offerings. Organic lead volume, while preferred, required some supplemental spend into targeted lead sources. Competition among lenders remains untamed, and the resulting pressure to provide consumers with more favorable rates has started to drive some margin compression in the GSE space. Increased business promotion spend and adversely impacted margins will likely persist as rates continue to increase. A welcome shift in Q4 2020 was the reemergence of a renewed investor interest in non-QM products. The appetite to buy these assets is gaining momentum. while the origination volume is catching up to guideline normalization. Credit risk overlays have been slowly adjusting to look more like a pre-COVID non-QM product, and the performance of the product, despite COVID-related forbearance concerns, has proven steady. Taking a focused approach to non-QM originations by way of product innovation, technology investment, and origination efficiencies is top of mind in the first quarter of 2021 and beyond. Investing in our wholesale channel is also a strategic step toward non-QM growth and innovation. We are committed to growing our core non-QM products while surveilling opportunities to serve consumers in more targeted offerings, such as purchase, second lien, and other alternative credit vehicles. Remaining agile in the market around credit and product is just as critical as doing so thoughtfully and responsibly. That concludes the financial results and our prepared remarks. We'll now open the call for questions.
spk07: Bear with us, please. We're having some difficulties with the dialing.
spk03: Excuse me, everyone. Our first question comes from the line of Trevor Cranston from JMP Securities. Your line is open.
spk09: Hi. Thanks. I guess the first question is, You know, you guys touched on the margin compression and increased competition somewhat in the prepared remarks. Can you maybe provide some general color around, you know, with the movement in mortgage rates we've seen so far in the first quarter, you know, how, you know, what kind of magnitude of additional margin compression you think that will result in and you know, with that additional margin compression and your, you know, target funding levels, does that still come out to a level where you think the company, you know, can comfortably remain at a profitable level? Thanks.
spk08: Yeah, this is Paul. I can start by, you know, starting this and maybe someone else can jump in. Yeah, right now, based on what we're seeing, we expect, you know, Further margin compression in Q1, we're estimating between 15 and 20 basis points of additional margin compression. Again, as Tiffany touched on, it's really just due to the increase in rates and competition. Of course, in the next couple of weeks, that could change depending on what happens in the market, but that's sort of what we're anticipating now.
spk09: Okay, and is that – so is that – should I interpret that as like 15 to 20 basis points to lower margin kind of on a run rate going forward, or is that sort of the average number you're expecting for 1Q versus where you're at in 4Q?
spk06: Yeah, Trevor, this is George. You know, we don't give forward guidance, but, you know, with that amount of margin compression in the GSC product offset by what we believe would be – a shift in production to non-QM and jumbo where the margins are healthier, you know, we're fairly confident that we'll be able to continue to run platform at a positive rate.
spk05: Yeah, Trevor, this is Justin. You talked about the rate move. So kind of, I mean, obviously we're coming off of 2020, record lows in rates, historic refi volume because of how much, you know, borrowers could save on their monthly payments. So over the last few weeks, as we've seen rates tick up slightly here, our borrowers have had some initial shock to those rates. However, there's still a very healthy appetite for refinances in the market right now, based on what we've seen from publications as early as recently as Monday, indicating about half of the homeowners are currently in the money for refinances. So there's still a lot of ground to cover there. And so we do expect, you know, there'll be more competition in the industry, margins will tighten in a bit more, but as George mentioned, that really opens up opportunities for us because with a product like non-QM Jumbo where impact historically, that's our DNA, that's what we've done very, very well, that's where we can pivot nicely.
spk09: Okay, got it. That is helpful. And in terms of personnel expense, I think you guys commented briefly on, you know, the fact that increased competition for employees in the market has had some impact on that. Given that 4Q, you kind of hit the funding targets and capacity you guys have at the moment, is the personnel expense sort of at a good run rate level, or is that something that – you'd expect it to continue to tick up a little bit into the first quarter?
spk01: This is Tiffany. I would expect it to be more normalized. We certainly have some stretch capacity with the folks that we have on board, but the ramp up in the ad required a little bit more expense given the competition in the market right now. But now that we have folks in the door and we're producing well, we'll continue to build on our efficiency with the origination process and then also be able to stretch beyond the current headcount that we have with the same folks.
spk09: Got it. Um, and then maybe to, to touch on the, um, non QM and non agency products, um, for a moment, um, can you provide some additional color around sort of how the restart of that business has gone? Um, you know, in terms of, uh, you know, finding, you know, partners who are actively originating the product, um, And, you know, how much you think that'll change as a result of maybe some refi business dropping off now that rates have moved higher. And then as a second part of that, I guess, you know, when we think back to where the non-QEM business was pre-COVID of last year and where margins were, kind of how would you kind of compare how you expect that business to look as it ramps up over the course of this year versus where it was before the shutdown?
spk02: Sure, Trevor. This is Tom Donatacci. We're already seeing origination growth in the non-QM sector and anticipate to continue growing through 2021 into 2022, with S&P predicting we could see levels as high as $25 billion in originations, levels not seen since 2019. While the halt to the market in early 2020 for both originations and securitizations was industry-wide, the recovery began soon after, and there's been a steady march towards pre-crisis market conditions in both guidelines and pricing, with securitizations of both new originations and portfolios held since early 2020 being well received by the market. A number of factors are supporting the stabilization and the return of the market and volume. One is extraordinary depth of demand from investors. created not just in appetite for volume, but also as an expanded list of buyers greater than what we had seen in 2019. These investors are able not only to buy dependent upon a securitization exit strategy, but many have entered with the ability to balance sheet the product, which creates additional stability in the market in the event of another market dislocation. The quality underwriting guidelines have improved market-wide with most product being originated to a more conservative profile based on stronger borrowers. Those that had focused on the lower end of the credit box have had to move up the curve to take advantage of demand in the market. Impact is always focused on higher quality non-QM originations, so our criteria hasn't had to shift from the pre-crisis credit box nearly as much as many of the players in the marketplace. Past originations have continued to perform well, despite some of the economic conditions over the past year resulting in fewer forbearance requests, and of those requesting forbearance, many continuing to make their payments. As these requests expire or retire, the universe of potential borrowers continues to grow. Historically, you know, per Paul's comments on margins, Historically, low rates and wide margins over the last year have migrated many loan officers who had historically focused on non-QM to take advantage of the refinanceable market for GSE products. With rates rising and margins compressing, we're seeing a return of these producers to the non-QM sector, which should boost origination volumes going forward. Lastly, the MBA anticipates purchase demand to exceed refinance demand on a go-forward basis. This is also a positive indicator for the non-QM market as business owners and real estate investors that rely on non-QM product offerings like bank statement and DSCR programs are typically strong drivers in the purchase market. For these reasons and our long history in the alternative credit space, we're bullish on this sector and our ability to participate competitively in non-QM going forward.
spk09: Okay, that's really helpful, Culler. So when you think about the overall funding capacity of the company as a whole, you know, as the non-QM piece presumably grows over the course of this year, do you guys have the capacity to kind of grow that alongside, you know, the business you're currently doing in the agency lending space, or would the anticipation be that you sort of shifts more of the funding capacity into the non-QM and it sort of replaces some of what you've been doing on the agency side.
spk06: Trevor, this is George. We have excess capacity to continue to grow the GSC portion of the business, which is primarily driven out of the call center. When I say capacity, I mean both with respect to liquidity for warehouse lending, with the equity to support the warehousing and with personnel. Non-QM business, we have liquidity. Again, the haircut's a bit deeper on non-QM, but we have the equity to support the non-QM growth concurrent with the existing run rate or even a little bit higher run rate in GSC. We've got warehouse capacity for non-QM, and we've got capacity terms of human capacity in terms of operating plant around non-QM. And that last piece has been added in the fourth quarter to pipeline business, and so we'll continue to build upon that in the first quarter. But we don't have any limitations on being able to continue to build on what we've created in the call center and at the same time concurrently build out the non-QM franchise.
spk05: And Trevor, it's Justin. So while TPO, as George indicated, will remain, you know, laser focused on non-QM originations, if you remember from years past, one thing that made us very successful within the call center for originating non-QM, albeit, you know, 25 to 50 million a month of that product, was standing up an independent team that would originate that product. So we would just adjust internally for that. But that was something that's we, unlike other lenders, were able to do successfully, which was originate non-QM through the call center.
spk06: Yeah, we haven't yet begun to spend, to drive any business promotion out of a call center to non-QM, quite frankly, because the lead generation has been, cost of customer acquisition has been the minimus around GSE production. But we'll We'll push some of our advertising spend into the non-QM effort in the call center, and you'll see that at the end of the first quarter. It might take root in the call center in the second quarter and early third quarter of this year. Great. Okay.
spk09: That makes a lot of sense. Appreciate the comments. Thank you, guys.
spk06: You're welcome, Trevor. Thank you.
spk05: So at this time, it doesn't look like we have any other questions. questions in the queue so at this point thank you everyone for joining us and we'll circle back in early May with our first quarter results. Thank you.
spk03: This concludes today's conference call. Thank you all for participating. You may now disconnect.
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