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Operator
Good afternoon and welcome to the Velocity Financial Incorporated conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Mr. Chris Altman, Chief Accounting Officer. Please go ahead.
Chris Altman
Thank you, Melanie. Hello, everyone, and thank you for joining us today for the discussion of Velocity Financial's second quarter 2021 results. Joining me today are Chris Farrar, Velocity's President and Chief Executive Officer, and Mark Sapaniak, Velocity's Chief Financial Officer. Earlier this afternoon, we released our second quarter 2021 press release and the accompanying earnings presentation, which are available on our industrial 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 filings with the Securities and Exchange Commission. Also note, the content of this 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 may also refer to certain non-GAAP measures on this call. For reconciliations of these non-GAAP measures, you should refer to the earnings materials on our Investor Relations website. And 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 some opening remarks.
Melanie
Thanks, Chris, and I'd like to welcome everyone to our second quarter management call. Obviously, we're very pleased with the outstanding quarter and results that were just released. We experienced favorable trends in new originations, delinquencies, NPL resolutions, net interest margin and EPS. We see the improving fundamentals in the economy translating to better performance in our portfolio as well as increasing demand for new financing. Tailwinds are very helpful to the business and our team is well positioned to capitalize on this favorable environment specifically within our market niche. Our special servicing team had another very strong quarter of recoveries as we continue to resolve delinquent loans profitably Gains we recognized were impressive and we saw a dramatic increase in realized NPL interest from these efforts. Residential real estate markets remain strong and we're seeing a healthy recovery in our segment of the commercial real estate market as well. Investor demand for our type of real estate is real and growing. Market conditions have helped us resolve NPLs and I want to congratulate our special servicing team on another great quarter. With respect to financing, we recently added another warehouse lending relationship and just launched our second securitization of the year earlier today. Capital markets continue to search for yield, and we're seeing robust demand for securitized products. As some of our older deals season, in the future we plan to collapse them and take advantage of these lower rates. From an equity perspective, later in the presentation we'll provide some new insight into how we think about the value of our business and introduce a new non-GAAP measure demonstrating the economic value of our equity. Our goal there is to impart a simple understanding of the real value embedded in our platform. The team is very proud of the business we've built and the results we've delivered. We plan to take full advantage of the great opportunities that lie ahead. And we appreciate everyone who supports us in pursuing those goals. That concludes my prepared remarks. And with that, we'll turn over to the presentation materials and start the presentation on page three of the PDF. Very strong net income. Core EPS of 25 cents a share, up 25% sequentially over the 20 20 cents that reported in Q1. The biggest driver there was the pickup in net interest income from curing non-performing assets. And you can see that translated directly into our NIM, NIM up 73 bps to 483. These things are lumpy and it's difficult for us to forecast and predict when delinquent loans are going to cure when somebody is going to reinstate or pay off. So we expect going forward you'll see some volatility in NIM there. We always expect to collect that past due amount. We just don't know the exact timing and when that's actually going to fall. And then all those earnings obviously translate into a nice pickup in book value. On the loan production side, very healthy quarter. little over $250 million in originations, up 10% sequentially. We also saw an improvement in the non-performing loans. That was a decrease of 153 bps quarter over quarter. So we're seeing nice trends there, continuing to see those delinquent assets get resolved. As we've mentioned before, it takes time, but it's definitely headed in the right direction. In terms of the NPL and REO resolutions, again, another really strong quarter. I think one of the strongest we've had, 103.9 of UPS in terms of gains above the contractual principle and interest. So again, still making money off of delinquent assets, which obviously is very unique. From a financing and capital perspective, we did complete our 2021 securitization earlier in the year with a weighted average rate of 1%. Obviously, those costs of funds are very helpful to driving strong ROEs and good margins. Also, earlier in the quarter, we were very excited to see that we were added to the Russell 2000 and 3000 industries. That was a nice little boost for us. And then subsequent to the end of the quarter, we added the fifth warehouse line that I had mentioned earlier in our call. So we've got a very broad base of good partners that will help us grow and fund future growth. Page four, just going to walk you through core income quickly and where value sits. Poor income of $8.5 million excludes, obviously, the million-dollar loan loss provision that we released as part of our CECL reserve process. Included in GAAP net income was almost $7 million of realized contractual interest, default interest, and prepayment fee, 59% increase from the first quarter. So, again, very strong performance there on the resolutions. And then nice pickup in book value per share, so ended the quarter nicely there. Majority of the pickup here in just kind of portfolio earnings come all of the assets. So that kind of wraps up my two slides, and I'll turn it over to Mark to take you through the next several slides.
Chris
Thanks, Chris. Good afternoon and good evening, everybody. On page five of the deck, this really shows how the loan production momentum has continued to build and going from 179 million at Q4 to 233 to over 256 million per Q2. So 10% quarter over quarter from Q1 to Q2 increase in our production volume. And that's driven by both an increase in our long-term product that was up about 4% quarter over quarter and also in Q2 we reintroduced our short-term product. When we first started resuming loans back in fourth quarter last year, we were holding back on the short-term product. So we reintroduced that in Q2, and you can see we funded just under $15 million in our short-term product, and have had very good demand and applications coming in on that product. Year-to-date, we're just under $490 million in production, so I think we're well on our way to hitting a billion dollars for the year. So again, continued great momentum and growth coming out of the COVID environment. And as a point of reference, in July, we funded $104 million in loans. So again, very good momentum on our loan portfolio. On page six, we have that type of production coming through. It continues to grow our overall portfolio. As we said, we have a portfolio with a locked-in spread under the securitizations. And you see the portfolio ended the quarter at $2.07 billion. So it's under $2.1 billion. So nice growth now for 2021 in that portfolio. And at the same time, while we're growing the portfolio, we're continuing to hold our loan-to-value ratios low at about 56% LTV. So nice, strong growth coming through and holding that LTV consistent. On page seven, portfolio type of margin is it generating? Well, for Q2, it generated a 4.83% net interest margin. That was an increase of 73 basis points from the 4.10 in Q1. As Chris alluded to, the increase is mainly driven by the strong NPL resolution activity of $7 million in cash non-performing interest comprised of prior contractual interest that came in, default interest, as well as prepayment fees. So a very strong resolution month coming into the quarter, bringing us to the 483. That is lumpy. It's not something that's predictable every quarter because it's booked on a cash basis. but it was very strong for Q2. Take a look at the bottom right. You can see that we also had a decrease in our cost of funds. So if you look at it overall, our yield went up from $841 to $890 on the loans due to that MPL resolution strength in Q2. But at the same time, our cost of funds decreased 20 basis points from $501 to $481, largely impacted by the securitization that we did in Q2 at a low fixed rate of 1.73%. On page 8, we take a look at our non-performing portfolio. Non-performing portfolio has been trending downward since the end of 2020. So we're actually down almost 2% from where we ended up 2020 at 17.2% non-performing. End of Q2 this year at 15.3%. So we had said that we were going to continuously try to bring that non-performing rate down. It would take some time. It wasn't going to happen overnight. But with the special servicing department we have, low LTV on the loans and strong resolution activity that we're seeing, we're continuing trying to bring that non-performing rate down. And that's what we've seen so far during 2021 coming down almost 2%. Page nine, in terms of the resolution activity, this gives you the kind of the breakout between our long-term and short-term product for Q1 and Q2 of 2021 on the NPL resolutions. Very, very strong resolutions for the year. You added up both quarters. We had resolved over $108 million of UPB for an overall $3.6 million gain, which translates into a 3.4% gain on these NPL resolutions for 2021 over and above the contractual principle and interest. So we've previously indicated that going back six, seven year trend, Our NPL resolutions have always been very strong. We normally realize around a three-point gain. And coming out of the pandemic for 21, we're right on track at a 3.4% gain for the first six months of this year. Page 10 is our CECL reserve. As Chris had mentioned, the CECL reserve, we took it down from 5.8 million at the end of Q1 to just about 4 million, 3 million, 963 at the end of Q2. That was mainly driven by the macroeconomic forecast. Remember the CECL Reserve is comprised of a baseline reserve, which looks at your historical loss rate. But then under the new CECL requirements, you have to do a forward projection, adjusting that baseline reserve by a macroeconomic forecast looking forward. And we've been using a COVID stress macroeconomic forecast. We've been using that since I think second quarter of last year when the pandemic broke out in our modeling system. We're continuing to use that COVID stress scenario forecast. But the stress forecast, because of the improvement in the U.S. economy, the stress forecast for Q2 showed an improvement in the reserve needed on a go-forward basis by about $900,000 versus where it was in Q1. So a nice pickup because of the improvement in the economy. And where we sit at the end of June, you can see it's 19 basis points of reserve based on total UPB outstanding. kind of as a point of reference, as of 12-31-19, pre-pandemic, we were at 12 basis points of reserve on about a billion-eight portfolio. So even by bringing that reserve down, we're still more than 50% higher in terms of a rate on outstanding UPB now at the end of Q2 than we were at the end of the 2019 year prior to the pandemic. So we feel very good about that reserve. And given the NPL resolutions that we just went through, resolving over 93%, 94% of our non-performing loans with a 3.4% gain, we feel very good with the reserve that we have. The other item at the bottom right of page 10, the charge-offs for the quarter, $986,000. Charge-offs were higher than Q1. Of that $986,000, there was one loan that had a $420,000 charge-off. So one loan at $420,000, which accounted for a little bit less than half of that total for the quarter, and that loan at $420,000, That was already reserved for back in Q1. So that was already part of our loan loss reserve. It did not hit P&L in the 420 and Q2. It was already part of a reserve. We knew about it. We had it reserved. So on a run rate basis, if you look at the six months of 2021, on a run rate, we're still looking at about five basis points of total outstanding UPV in terms of charge-offs. And that's right on top of what our historical run rate has been for the last six, seven years has been like 4.8 basis points of total UPV. First six months this year is five basis points. So we're still right on top of our run rate for charge-offs, and I feel really good we're at on that. Chris, I'll turn it back to you for the outlook on Velocity's business.
Melanie
Great. Thank you, Mark. Appreciate it. On 11, we kind of mentioned we've seen improvement in the economy and see signs that we expect that to continue into the second half of this year. The real estate markets, as I mentioned, are doing very well, and there's been a lot of chatter about government assistance coming out for landlords and renters. I think most of it is still working its way through the system, but we are trying to help as many landlords and borrowers and renters as we can by just disseminating information and getting the info out to them to let them know that assistance is available. So we think that will also be helpful as we move forward here and people figure out how to access those resources. In terms of net interest income and the portfolio, growing earnings, obviously by growing the portfolio we see good demand across all product types. We're on a net basis growing the portfolio, which also should drive future net interest income and expect to continue to see that strong performance on the NPLs. In terms of the capital structure, we think the next securitization and then another one here in probably Q4, expect those to go very well and see good demand there. As I mentioned on my opening remarks, we are looking probably sometime this year to collapse a couple of the older deals and refi them, which should be a nice tailwind for us. the warehouse line. On 12, this is a new slide for us. Last time we promised that we were going to introduce something. Taking a step back, we sort of feel like the market doesn't appreciate all the value that we see in the platform and feel that our equity is undervalued, so we wanted to try to create a very simple analysis of how we look at it. So what we did here is we did kind of a build-up of this economic value. And the first bar on the chart is our fully diluted value of equity. That's basically just today's book value plus the conversion of $90 million of preferred equity that we expect will happen in October. That's the earliest we can... exercise that option and based on where the stock's trading we expect to be able to do that so that that gives you the first base component here the middle section the orange section is just a simple discounted npv of all of the earnings we expect to make off of all of our retained interests and securitizations so we're calling that an embedded gain in the securitized portfolio And so what we did is take all of those projected cash flows with the CPRs, the CDRs, and all of the relevant assumptions, used a 10% discount rate, brought that back to today, NPV, and got $222 million. And then thirdly, on top of that, and just in talking with various investment bankers and capital markets folks, we're seeing a number of platforms trade in the private side and they're telling us that typical premiums for platforms are running in the 10 to 15% of annual run rate originations and origination volumes. So we took kind of the lower end of that and said if we did a billion dollars a year and 10% of that would imply $100 million of platform value. When you add those all up, you can see in our eyes, you're worth of $19 of economic value per share, fully diluted. And so we think that is an important thing to communicate to the market and help everyone understand that not only do we have a great earnings story, but there's a real solid book value story here as well. So we think that's underappreciated and hope that the market will start to recognize that value as we eliminate it. And that wraps up all of our presentation here, so I'll turn it back to Melanie for any questions.
Operator
Thank you. We will now begin the question and answer session. To ask a question, you may press star then 1 on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. The first question comes from Steve Delaney with JMP Securities. Please go ahead.
Steve Delaney
Hello, everyone. I hope you're doing well and staying safe. Great, great quarter. I'd love to see the progress that you're making. Gosh, a lot to unpack here. Maybe first, just if I could start with the reintroduction of the short-term bridge loans. Chris, should we view those as, you know, loans held for sale in whole loan format? And I think you did about $15 million in the first quarter. Historically, what did you realize in terms of a premium gain on sale? And is that, in fact, the way they would be sold rather than some type of securitization? Thank you.
Melanie
sure thanks steve good to hear from you so we are holding those on the balance sheet as held for investment right now because we do believe we've got a securitization exit in the works for those we certainly could sell them on a whole loan basis and when we did that in the past What we were typically doing was taking like a participating interest, and so we were making a couple of points up front, and then on the back end we were making an interest spread. So, I mean, all in, if you wanted to figure something, you could probably figure like a 103.5 to 104 price. Okay. But our hope is that we're going to be able to execute on the securitization strategy and just earn the spread over time, which we think could actually be more meaningful. So we do have the flexibility to do either one, but in terms of modeling, we're going to plan to hold it.
Steve Delaney
Okay, great. And the NIM, obviously, 73 basis points in a quarter to 43 is a big quarterly move, and Mark explained a lot of that, I think, with with the MPL and some of the recoveries. In your mind, as you model it out, and I don't know if Mark has built sort of a 2022 model yet, but do you have any sense for looking at the loan yields seem crazy sticky, you know, at least your legacy stuff, everything's like 7% and 8%. And so it doesn't sound like you're going to get all that much compression from on the loan yield side, and you're going to pick up on the financing. But any sense of how much further improvement there is in the NIM from the 483 in the second quarter? Do you have a target?
Melanie
Yeah, thank you. I think, you know, we're not, you know, kind of putting out official guidance, but we think that the right number to use is probably what, you know, it's somewhere between Q1 and Q2. I think Q2 is a little elevated. And, again, you know, if we get five or six loans that cure that have been delinquent for 15 months, you get all this interest in one quarter, right? So that's why we were kind of trying to warn.
Steve Delaney
Lumpy.
Melanie
Lumpiness, yeah. So I think it's somewhere between those two. I mean, I would probably point you more towards, like, the four and a quarter range.
Chris Altman
Okay.
Melanie
Where will my model NIM now? That's before the corporate debt. That's just on the portfolio.
Steve Delaney
Oh, sure, that's portfolio without everything else, yeah. Okay, great. Well, thanks. I'll leave some other stuff for the rest of the guys on the line, but thanks for your comments. Thank you, Steve.
Operator
Thank you. Our next question comes from Stephen Laws with Raymond James. Please go ahead.
Stephen Laws
Hi, good afternoon, Chris, Chris, and Mark. As Steve said, great hearing from you, and you can congratulate. You guys have really accomplished a lot in the last 15 months from where we were, I think, about a year ago. Really positive outlook. I think Steve covered a good bit on the origination side and then the prepared remarks. Could you maybe spend a little more time on the cost of funds? you know, seems like, you know, big opportunity there. I know you're looking at collapsing a couple of deals. Can you try to quantify that for us? And over time, where should we see that cost of funds trend and how quickly we'll get there? And is there some inflection point in six or nine months where it'll accelerate lower?
Melanie
Mark, do you want to try to hit that one?
Chris
Yeah, some of the older... Hi, Stephen, by the way. Nice to talk to you again. some of the older securitizations that are close to being able to be collapsed are currently running probably somewhere in, you know, a 5% to 6% overall cost of funds handle. And we think with refinancing, releveraging these in new securitizations, that we could bring that cost of funds into somewhere in the two handle. So a pretty nice pickup on that.
Stephen Laws
Thanks for that color. And, you know, thinking about the origination business, you know, mentioned in the prepared remarks about, you know, on pace kind of trending for about a billion a year at 104 in July. You know, with your current platform and scale, you know, where can that number go? Is there still significant opportunity on the upside as far as the monthly volume, or are we kind of at a good pace now to feed the business?
Melanie
Yeah, I think there's definitely room to go. We want to grow, you know, Smartly, we don't want to get over our skis and go too aggressive, but there's definitely more run room. There's more demand. So we think those volumes will continue to grow as we add more people and expand more relationships. So, yeah, we definitely expect higher volumes next year and think that there's plenty of room to run there.
Stephen Laws
Great. Thanks for the comments, Chris. Appreciate your time this afternoon.
Melanie
You're welcome.
Chris
Thank you. Steve, one thing to keep in mind is when we hit the billion dollars in 2019, that was offering the short-term product pretty much most of the year. And we're already almost halfway to a billion dollars the first six months of this year, and we just started offering the short-term product and reintroducing it the last quarter.
Stephen Laws
Where would you like to see that get to? I think you said 15 million. Is there any kind of target, maybe a quarterly run rate next year on that product?
Melanie
You know, we just came out of the gate with that, so we'll have to see where it goes. But I would think that it's easily somewhere in the neighborhood of $30 million to $50 million a month for sure.
Stephen Laws
Yeah, it seems like the opportunity to really grow volumes next year then. Great. Thanks for that additional comment, Mark. Appreciate it.
Operator
Thank you. Our next question comes from Aaron Gainovich with Citi. Please go ahead.
Aaron Gainovich
Thanks. The excess income that you received from penalty interest that you recovered from the quarter, did you say that that was $7 million for the quarter? And I'm assuming you have some resolutions each quarter. So I'm just trying to get an idea of what kind of a more kind of normal level. Is it like half that, or is it just trying to frame out a little bit?
Chris
Hey, Aaron, this is Mark. $7 million was the actual cash received in Q2 related to non-performing loans where we had already taken the interest income off our books because once a loan goes non-performing, we reverse out all the interest income and put it on non-accrual. And then we wait for the actual resolution of the cash to come in to rebook that income. So $7 million was actual cash that came in that was past due contractual interest that came in in the second quarter. Remember, we charged a 4% default rate. It was the default interest to either come current or pay off the loan or pay the loan current. And then depending on the loan, if it was in a prepayment window, it could be prepayment fees as well. So the $7 million was all cash that came in on not performing loans. I think that was about a 40% increase over Q1. But in terms of a run rate, as we said, it's really hard to project that. Yeah, I'd like to say take an average of Q1 and Q2, but I think Q2 was very high. It's probably the highest we've had at least since I've been with the company, in terms of non-performing resolution cash. And it's very hard to predict because we don't book it until we get the cash. We work hard to resolve most of our loans. We get a 3% gain on them, but we just never know when we're going to get that resolution and when that gain is going to come through in cash and book it on a cash basis. It's really hard to predict that.
Aaron Gainovich
Yeah, I understand that. That's helpful. The other question I had was on... a new non-performing loan formation? Um, you know, clearly you've resolved quite a few loans for the quarter, but you also had some, some new additions is, is, is the new addition there, the pace of new additions that are coming in non-performing, uh, beginning to slow or what are you, what are your views on that side?
Melanie
Yeah. Um, we, we, we do see that, um, slowing, um, the majority of those loans are, um, folks that were in some type of covid forbearance and they're failing they're just not making it so um i think you know from that perspective we're encouraged that it's not you know new new originations or or newer borrowers it's mostly driven by um folks that are already struggling so um I think that's why you see the offset, and that's why we've been telling everyone it's going to take time to kind of work through this whole backlog as these borrowers deal with their reality and figure out how to get resolved. So it's mostly the forbearance loans that we're incorporating. Okay.
Chris Altman
All right. Thank you.
Melanie
Yep. Thank you, Aaron.
Operator
Once again, if you wish to ask a question, please press star, then 1. Your next question comes from Don Fendetti with Wells Fargo. Please go ahead.
Don Fendetti
Hi. I have a couple questions. One, Chris, just checking in on you know, the competitive dynamic. It seems like your business has largely been very fragmented, smaller private lenders. You know, is that still the case coming out of COVID? And are there any strategic structures you've looked at, like doing more JVs and things of that nature down the road?
Melanie
Yeah. Hi, Don. You're right. Your characterization is right. It's highly fragmented, and we continue to, we think, take share from smaller private lenders. We have looked in the past at some JVs. We do have a couple in the works right now and one I can think in particular is a private REIT that has been aggressively acquiring assets and so we agreed to be their financial partner but not necessarily a JV with another institution. By and large, the majority of the business is still coming through our brokers, and that's really where we're seeing the growth.
Don Fendetti
Okay. And then I noticed the production in the quarter versus Q1, there was more commercial. I was just curious if you could touch upon that and if you expect, you know, that to grow faster than the investor one-to-four rental.
Melanie
Yeah, I think – Our view was that we were somewhat cautious on it when we restarted back in the fall last year. So we were just a little tougher on that product just to make sure where COVID went and if businesses were going to be allowed to reopen and how long that was going to take. So I attribute most of that to COVID. outlook on those borrowers and those types of assets. But I think going forward, I would expect the growth to be pretty balanced between the two product types.
Don Fendetti
Got it. Okay. Thanks. I'm all set. Sure.
Operator
This concludes our question and answer session. I would like to turn the conference back over to Chris Farrar for any closing remarks.
Melanie
Thank you all for joining the call. We're obviously very pleased to present the results today and appreciate everyone taking the time to listen to our presentation and look forward to speaking to you again soon. So thank you all.
Operator
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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