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Operator
Good day and welcome to the Velocity Financial Inc. Q3 2020 earnings call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing star then zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on a touch-tone phone. To withdraw your question, please press star then two. Please note this event is being recorded. I would like now to turn the conference over to Chris Holtman, Chief Accounting Officer. Please go ahead.
Chris Holtman
Thank you, Matt. Hello, everyone, and thank you for participating in Velocity Financial's third quarter 2020 earnings call. Joining me today are Chris Farrar, Velocity's President and Chief Executive Officer. Mark Sapaniak, Velocity's Chief Financial Officer. Earlier this afternoon, we released our third quarter 2020 press release and the accompanying earnings presentation, which are available on our investor relations website. I'd like to remind everybody that today's call may include forward-looking statements, which are uncertain and outside of the company's control, and actual results may differ materially. For discussion of some of the risks and other factors that could affect results, please see the risk factors and other cautionary statements made in our communications with shareholders, including the risk factors disclosed in our annual and quarterly reports. Also note that the content of this conference call contains time-sensitive information that is accurate only as of today, and we do not undertake any duty to update forward-looking statements. We will also refer to certain non-GAAP measures on this call For reconciliations of these non-GAAP measures, you should refer to the press release and earnings presentation on our investor relations website. Finally, today's call is being recorded and will be available on the company's website later today. I will now turn the call over to Chris Farrar for opening remarks.
Matt
Thanks, Chris, and thank you all for joining us today. We had a great quarter and excited to host the call today. On our last earnings call, I outlined our plans to restart originations in the third quarter, and I'm very excited to report that we are completely operational. Our new applications have returned to pre-COVID levels, and the pipeline is expanding rapidly. The silver lining of our production pause was a chance to work on the nice-to-have projects that are often tough to accomplish when a company is growing. We used the downtime to reevaluate our entire production platform, and we made significant improvements to our process as well as our technology. These improvements will make us more efficient and more customer-friendly going forward. We also restructured job functions and responsibilities, which resulted in a reduction of force at the end of September. While these decisions are never easy, our team is convinced that they were necessary and beneficial to our future growth. In terms of the portfolio, we saw a stabilization of the non-performing loans and our asset managers continued to do an excellent job of resolving delinquent loans. We continue to see strong recovery rates and the real estate markets are performing better than many had predicted. Additionally, it's important to note that we saw provision expense return to a normalized level in Q3 as the economy is performing above the adverse levels that we were assuming in our CECL model. Looking forward, our team is working hard to create new relationships on the liability side of the balance sheet to eliminate mark-to-market risk and explore other debt structures to finance our growth during the fourth quarter and well into 21. With regard to our people, most of us continue to work remotely, but we've recently allowed certain of our team members to return to work in our physical locations so long as protocols are followed. I'm happy to report that we've had minimal issues by reopening our offices. Fortunately, we are healthy, motivated, and happy to be serving our customers again. With that, we'll turn to our presentation materials. It's a relatively short and straightforward presentation today, so I'm going to just go through it top to bottom. Mark is on the call as well, and we'll both be available for Q&A. Obviously, from an earnings perspective, we're very pleased. Net income up significantly, as I mentioned in my opening remarks, driven largely by a return to just normalized provision expense. Portfolio NIM expanded as we saw fewer NPL loans, and we're very pleased with the earnings result for the quarter. In terms of production, I've already highlighted that we got restarted but had tremendous response from the market, saw near pre-COVID levels right out of the gate, and I'm very pleased to see how quickly our customers have been responding to our reopening. In terms of resolutions, again, very strong for the quarter, 103.5 on assets resolved. We expect that to... good performance to continue going forward, and we see strong real estate markets as we continue to resolve these assets. Another important milestone in the quarter, about $335 million of loans that were in the forbearance program were actually brought current. Any amounts that were past due were tacked on to the end of the loan, and they sit in a non-interest-bearing account that will be recovered upon liquidation. So that was a big slug of the forbearance loans that we had done in the prior quarter coming back to current status. So that was a very good improvement for us in the third quarter. And from a financing and capital perspective, we're working on some new agreements right now that all have non-mark-to-market provisions, as we've indicated in the past. That's our desire and our plan going forward, and we're making very good progress there. And looking forward to doing our next securitization in Q1. Turning to page four, from just a core earnings perspective, You can see core earnings were a touch higher as a result of the workforce reduction costs and the charge that we took there from restructuring. So good results there and good book value growth as a result of the earnings in the quarter. On five, I mentioned the good asset resolution activity. We continue to see strong growth. performance there and good resolutions as loans are paying off and borrowers are rectifying delinquent assets and expect to continue that performance on a go-forward basis. Turning to six, in terms of the portfolio, the one significant transaction in the third quarter was our transfer of about $214 million of HFS loans to HFI. It's somewhat confusing. I think the gap requirements can sometimes distort the picture a little bit. Essentially, you'll see in our loan loss provision a number of 1.6 million, so it might look at first blush that reserve provision is up for the quarter, but we had a offsetting low-com adjustment on the books already for those HFS loans. And so this is really just a reclassification under the GAAP requirements. And so it actually ended up being $141,000 positive to income as a result of the reclass. And so that transaction took place during the third quarter as a result of our securitization of those loans. but resulted in no real meaningful change to loan loss provision. On seven, we talked about the production restart. Got really great response from our customers in Generate Velocity. Our broker portal had just under 400 new brokers sign up with us. And some of the technology enhancements there were to find ways for folks to interact with us more seamlessly, make the website more friendly, and just continually improve that broker and borrower experience. And early returns are fantastic. We're getting much better application level and response level than we had even forecasted or hoped for. So all those investments and enhancements, I think, are going to continue to serve us well as we expand. Turning to page eight, net interest income. I mentioned the NIM expanded in the quarter, primarily driven by fewer new NPLs. And as we go forward, we hope that we can continue to improve on this NIM as we expand and grow the portfolio. On nine, in terms of loan portfolio performance, you can see on the left-hand side, non-accrual loans stabilized and ticked down slightly. Our projection there and our expectation is that we have, in fact, stabilized. And over the next 12 to 18 months, we expect that to trend down as we resolve assets and as they come off. the balance sheet, so we're pleased with what's going on there from an NPL perspective, especially in light of the positive resolutions. Excuse me, from a charge-off perspective on the right-hand side, this is the only kind of ding in the quarter. Unfortunately, we had one large loan that charged off. It was not a result of COVID. It was a large loan that we made about a year ago, and it was kind of a Murphy's Law loan. Everything that could have gone wrong did go wrong. We had some people internally that didn't follow procedure, and we let them go. We are pursuing this borrower legally for a deficiency judgment, and we're also actually pursuing the insurance from the appraiser. I don't want to get too far into the weeds, but if we need to in Q&A, we can. But the bigger point that I'm trying to make here is that it was kind of a one-off unfortunate situation. I think the last time something like this happened was five or six years ago, and more importantly, it's not an indication of a larger trend or a large number of loans that were delinquent that we had to charge off. It was just kind of an unfortunate event on our side, and we believe one time and not indicative of future performance. On 10, just a little perspective on the CECL Reserve. You can see running right around 29 basis points. We think we're very well reserved. I did mention that we use an adverse, highly stressed forecast model for this CECL calculation, and so far the economy has been performing better than those assumptions and those outcomes are predicted to be. We'll see how things go in the future, but we feel very good about our CECL reserve and the level of of reserve vis-a-vis the portfolio. On 11, just talking about the future, we expect continued strong demand for our products. We think there's some market dynamics there. We think there's some competitive dynamics there, but very pleased to see the response that we've received so far. Performance, we're very hopeful that we've got our arms around the delinquency and continue to work that off. And we're seeing pockets of weakness across the country, but overall in terms of real estate values, they're holding up very well. And we remain very optimistic on our ability to continue to liquidate delinquent assets. Lastly, in terms of profitability and growth, obviously very excited to be putting new assets on the balance sheet and believe that by Q2 next year, we'll be back to pre-COVID origination levels and driving higher net interest income into the profitability. And then an important, obviously, foundation in that strategy is to continue to expand our financing capacity, and we're working on that especially especially in the warehouse side of the balance sheet, just trying to make sure that we eliminate that mark-to-market risk. So I think we've put all the pieces in place to have a great year next year and continue to expand on our growth plans. So as I said, that was a pretty quick presentation, pretty high level, and I think it'd probably be appropriate to just open it up for Q&A now for both myself or Mark.
Operator
We will now begin the question and answer session. To ask a question, you may press star then one on your touch tone phone. If you're using a speaker phone, please pick up your handset before pressing the keys. And if any time your question has been addressed and you would like to withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Our first question comes from Steven Laws with Raymond James. Please go ahead. Good afternoon.
Steven Laws
Chris, I guess first, can you talk about, I think, 63 million of production in October. Is that kind of a good run rate as we think about November and December? Is there seasonality, or how do you think about that ramping? And kind of coupled with that, it seems like the focus recently has been exclusively one-to-four rental. Is that likely to continue for the foreseeable future, or how do you think about the mix of the new loan production?
Matt
Sure. So I think... You know, it takes some time for applications to build and for your pipeline to build. So I don't think the $63 million is the run rate. We do expect that to increase over the quarter. And there's a little bit of seasonality in Q1, kind of January, February. So, you know, it could maybe level off or pull back a little in that Q1, but we think By the time we get to Q2, we'll be back to more normalized levels that we were, you know, pre-COVID. And then in terms of the second part of your question, we tightened up on some of our small commercial guidelines and intentionally, you know, wanted to have a little bit less exposure there. just in light of obviously all of the things going on in the economy. So, yeah, I think on a go-forward basis, we would expect a higher level of the 1 to 4 production than the small commercial. You know, a little bit too new to rate, but I think it's going to be weighted a little more towards the 1 to 4.
Steven Laws
Great. Appreciate the color on that. And kind of as a follow-up, you know, given... You know, the trends we're seeing coming out of COVID with, you know, migration shifts. Have you, you know, about half the portfolio is New York and California. Have you seen a change in demand of where the loan applications are coming from? Or have you seen anything interesting to shift the geographic concentration of the loan demand? Yes.
Matt
Yeah, not yet, not yet. It's probably too new to rate. Still in the large MSAs, as you know, we like to stay in the more liquid markets, so I would expect our originations to continue there. A lot of what we do is out in the suburbs and has always been there, so we're seeing a lot of demand there. But I don't think there's anything material yet that we would highlight.
Steven Laws
Great. And then, Mark, you know, can you give us what goes into the other income line? You know, $1.3 million for the quarter. Nice pickup. It's been a little bit up and down this year. So can you give us an idea of what is in that line item and how do we think about that as we model forward?
Mark
Yeah, what's in the other income line? Hi, Steve. I do. What's in the other income line for Q3 is we talked about we moved the HFS loans, about $214 million worth of UPB, of held-for-sale loans out of the held-for-sale category up into held-for-investment because those loans were pledged in that securitization that we did in July. So once it's pledged for securitization, we're not able to sell it. We have to hold them. So GAAP requires you to move it up. So those loans, though, when they were held-for-sale, the held-for-sale loan, you apply lower-of-cost-for-market accounting. So we had already built up over time, ever since those loans were on the books, say, end of last year, January, February of this year, and we're still doing originations, we had built up a valuation allowance of about 1.3 million. That goes into other income as an expense. That sounds weird, but that's how a gap books it. When you're building up an allowance for a lower of cost or market valuation for an HFS loan, it's a contra other income. So we had built up a $1.3 million kind of write-off to other income over time, and it was sitting in this allowance account. Once we move those loans up into held for investment, you have to reverse out that allowance that you had put in other income so we actually took a positive 1.3 it's the reversal of that 1.3 allowance that we built up so that positive 1.3 is kind of a non-recurring big hit to other income because we reversed out that HFS allowance and when you move those loans up into HFI now it's an HFI loan they still have an allowance as well but that's called loan loss reserve so that's why you see the provision of about a million six provision expense but about a million two of that million six If that $1.3 million, that was another income, $1.2 million went up into provision expense. It was just a reclass from other income up into provision. So almost all that $1.3 million that you see is just that one-time reversal from moving HFS. Our other income is normally very, very small.
Steven Laws
Great. I appreciate the color there.
Matt
Stephen, one other thing I'll point out, just in the presentation materials, the last slide, slide 16, has a a breakout that walks you through that whole entry. There it is.
Steven Laws
I paused on 15 on my geographic question, so I appreciate you pointing that out. Lastly, and I'll drop off, but can you talk about financing costs went up due to where the markets were in June and July. It was good to get those deals done. Can you talk about, I know it's early for your targeted 1Q securitization, but maybe you know, where do you see the market today? What type of, I don't know if it's a margin you're thinking about or how you, you know, want to answer towards outlook for financing costs, but kind of how does the securitization market look today versus what, you know, what you were able to execute in June and July?
Matt
Yeah. So in talking to our investment bankers, we think it's significantly improved from that timeframe. And we've got some pretty good data points to show that. I think In terms of where our spreads will be, we think they will be at least where they were kind of pre-COVID. So spread, and what I mean by spread is I think our interest earning spread, in other words, the difference between the loan yield and our debt costs. So I think the result of all of the Fed intervention, we believe we'll be able to be back to to pre-COVID levels on a margin basis.
Steven Laws
Great. Well, appreciate the time this afternoon, and continue to do a good job. You guys recovered from this COVID impact from March, so good job with that. Thank you.
Matt
Thanks very much.
Operator
Our next question comes from Don Fandetti with Wells Fargo. Please go ahead.
Don Fandetti
Yes, can you talk a little bit about where yields are on new originations versus pre-COVID, and also can you reconcile the share count, the diluted shares, in terms of, you know, are the press and warrants in there, and are they all in there? I was just having gone through all the numbers in detail.
Matt
Sure. Hi, Don. I'll take the first part, and I'll let Mark cover the second one. On the first part, We're seeing coupons about 75 basis points lower than where we were pre-COVID. But we think on the debt side, it's probably lower than that. So, again, from a spread perspective, we think we'll be at least at our normal spreads, if not wider, going forward.
Mark
Hey, Don, this is Mark. In terms of the shares, if you're talking like on a fully diluted basis, there's a little over 20 million common shares outstanding. For Q3 on a fully diluted basis, that goes up to a little over 32 million shares because you have to take your average stock price for the quarter. Our average price was about 440. So all of the convertible preferred shares fall into the diluted category which is like 11.7 million shares because it has a 385 strike price so that's below the 440 so that goes into diluted and then if you recall there were the warrants were issued with like in two tiers two different strike prices a 296 strike price and a 494 well obviously the 296 strike price would be considered dilutive because it's under the 440 average velocity price but the second tier of the 490 or 491 strike price would not be dilutive because it's still more than the 440 average. So what's causing the extra 12 minute dilution is assuming that the preferred convertible converts and also the first tier of the warrants.
Operator
Thank you. Our next question comes from Steve Delaney with JMP Securities. Please go ahead.
Steve Delaney
Thanks. Hello, everyone. A couple of mine have been taken, but Chris, I was wondering if you could just provide, after the September reduction in force, if you could provide your current full-time headcount today versus where you stood at pre-COVID.
Matt
Yes, so we're reduced by 60 in terms of FTE.
Steve Delaney
Okay, and approximately how many does that put you with? I don't have the old figure in my mind.
Matt
I think we're 182. Yeah, okay.
Steve Delaney
Okay, very good. And then following up on Don's question on the coupons, I was going to ask the same thing. And if you're down 75, I'm looking at my rate sheet, it looks like the 10-year is probably down about 100, and credit spreads could be anywhere. But it sounds like maybe you're able to get a slightly higher coupon relative to the 10-year today than maybe you did you know, late last year or early this year? I don't even know if you even think about it versus the 10-year because what really matters is the MBS credit spread, right? But the 10-year, I measure everything off the 10-year because, you know, it's easy to find, right? You just look at your screen. Yep.
Matt
Yeah, yeah. No, I think you're thinking about it the right way. And the other thing that that doesn't immediately jump through is that, you know, we've reduced loan to value. So effectively we're getting a higher coupon for a lower loan to value loan. So when you put those two together, yes, we're, we're effectively getting a, at least the same spread, but probably a little bit wider than where we were pre COVID.
Steve Delaney
Better risk adjusted anyway. And what, what are you generally quoting on LTV today? What are you, where are you trying to come in?
Matt
So, Yeah, I mean, we reduced all of our commercial LTVs by 5%. Small balance, yeah. Yes, yeah. It's a smaller percentage of the production. So overall, I don't think you'll see as big of a notch down in terms of weighted average LTV because we're more skewed to the 1 to 4. Right. But for those assets, we're risk-adjusted. Got it.
Steve Delaney
Thank you for the comments.
Matt
Absolutely. Thank you.
Operator
This concludes our question and answer session. I would like to turn the conference back over to Chris Farrar, CEO, for any closing remarks.
Matt
I just want to say thanks to everybody for joining the call. We appreciate your support and interest, and we're available if you have further follow-ups. Thank you.
Operator
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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