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Operator: Good day and welcome to the Velocity Financial Q3 2023 Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mr. Chris Oltmann. Please go ahead.

Chris Oltmann: Thanks Rachel. Hello, everyone, and thank you for joining us today for the discussion of Velocity’s third quarter 2023 results. Joining me today are Chris Farrar, Velocity’s President and Chief Executive Officer; and Mark Szczepaniak, Velocity’s Chief Financial Officer. Earlier this afternoon, we released our third quarter 2023 results and the press release and accompanying presentation are available on our Investor Relations website. I want to remind everyone 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 a discussion of 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.

Please 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 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. And with that, I will now turn the call over to Chris Farrar.

Chris Farrar: Thank you, Chris and I’d like to welcome everyone to our third quarter earnings call. Earlier today, we released the results from a strong quarter as we continue to execute very well on our growth strategy. Our core earnings increased 29% over the prior year quarter, which is quite impressive, given the various headwinds we faced. Despite the uncertainty in various cross currents, we expect to continue to take market share and expand our portfolio. One of the key themes we’re experiencing is the tightening of credit from the banking system. We’re seeing more high-quality borrowers that have been turned away by traditional lenders come our way. We expect this trend towards alternative credit to continue for a long time, and our team is well positioned to capitalize as we’ve spent the last 19 years building our platform to shine in times like this.

Certainly, our pipeline is strong and growing, which allows us to be selective in extending credit as well as increase our coupon. In terms of our portfolio, we experienced minimal charge-offs this quarter in our special servicing team — favorably. Real estate markets and single-family rental and small-cap CRE are healthy in terms of valuation and outperforming — segments. We believe our focus on small properties with neighborhoods serving essential services will continue — strategy. Very busy in the capital markets, completing two securitizations in Q3, and we just priced our last deal of the year on Tuesday of this week. One of those securitizations is an inaugural transaction collateralized by our short-term loans with a revolving structure that allows us to replace loans that pay off with new similar production.

We also collapsed the last of our older sequential pay deals during the quarter. Our track record of strong credit performance allows us to access the capital markets sufficiently and enjoy support from a broad base of fixed income investors. The other significant policy change we made during the quarter was to hedge our future debt issuances backed by newly originated loans. Very fortunate in our timing as we offset most of the move in the underlying base rate treasuries before we priced our deal earlier this week. Hedges are cash flow hedges that will accrete into our income statement over time in support of our strategy of achieving a stable, predictable NIM. We will continue to hedge future debt issuances before we securitize as a good risk management practice.

Regardless of uncertainty about interest rates, the economy and other events outside our control, we will grow and be opportunistic. Our strategy is to remain nimble and lean on our many years of experience to navigate whatever comes our way. I want to congratulate all our team members on another great quarter. Our people are our greatest asset and we will continue to work hard for all shareholders. That concludes my prepared remarks and I’ll turn over to the earnings materials, starting on Page 3. As I mentioned, strong growth in core net income, very, very positive quarter there, stable NIM, up 10 bps from the prior quarter. We continue to put on new production coupons that are attractive in terms of our historical spreads. And then I also mentioned the hedge strategy, which didn’t affect earnings for Q3.

It will show up in our future deals, as I mentioned, over time as we issue those transactions. In terms of production and the loan portfolio, October was a record month for production, where, all throughout the year, we’ve seen volumes grow even while we’re raising coupons. So, we’re very encouraged there and liked the trends. In terms of NPLs, we were flat quarter-over-quarter and continue to realize positive gains as we resolve assets. Our team is doing a great job there. On financing and capital, I mentioned the two securitizations. We’re excited on the short-term product to be able to term out those loans and create that revolving structure. So, we’ve got additional capacity to grow that product going forward. In terms of warehouse and liquidity, we’re in good position there to support future growth.

Turning to Page 4. Very nice build in book value per share, which, you can see we’re up $0.43 Q-over-Q with a combination of portfolio earnings as well as other additional income generated in the quarter. Turning to Page 5, we’ve shown this slide for a number of quarters now and try to demonstrate that we believe there’s a significant amount of embedded equity in the platform. And one of the changes you’ll note, if you compare this to the prior quarter as the embedded gain in the securitized portfolio has grown pretty significantly, and that’s a result of us slowing our assumptions on prepay speeds. So, we did that during the quarter and as we assume slower prepay speeds, that’s obviously, going to extend out the portfolio and increase future earnings.

So, we think there’s a real good story here around the economic value of the equity that we’ve built in the platform. So, with that, I’ll turn it over to Mark to continue with the presentation.

Mark Szczepaniak: Thanks Chris. Hi everyone. Thanks for joining again our third quarter earnings call. On Page 6, loan production continues to improve during the year even with the current high interest rate environment. As you can see, Q3 production was almost $291 million in UPB, which is a 12.3% increase over Q2 and almost a 34% increase from our Q1 production. And the strong production growth during 2023 has occurred with the weighted average coupons with new originations for all three quarters remaining constant at about 11%, while the strong 2023 production growth at the higher WACs continues to demonstrate borrower demand for our products. As a result of the strong growth in production on Page 7 shows a similar growth in our overall loan portfolio.

Our total loan portfolio as of September 30th was almost $3.9 billion, which is a 4% — 4.2% increase from Q2, almost 13% increase on a year-over-year basis. The weighted average coupon on our total portfolio as of September 30th was 8.63%, that’s 23 basis points higher than at the end of Q2 and 92 basis points higher year-over-year compared to the third quarter of last year. And while our loan portfolio is growing, our loan-to-value ratio remains consistent on the overall portfolio at 68% and 2023 production, the LTV has actually averaged a little lower at 66%. On Page 8, our third quarter NIM increased 10 basis points over Q2. Our portfolio yield increased quarter-over-quarter by 14 basis points, while our cost of funds only increased by about 5%.

So, not only are we seeing growth in production, but we’re also seeing an increase in our NIM. On Page 9, our non-performing loan rate for Q3 was flat to 10% compared to Q2. And the ongoing strong collection efforts by our own special servicing department, as Chris mentioned, has continued to result in resolutions of our NPL loans at favorable gains. If you look at Page 10, it highlights the continued success of our NPL resolution efforts. In Q3, we resolved $65.7 million worth of UPB of NPL loans for a net gain of $1.2 million. Although not on this slide, if you take a look at all of 2023, so for 2023 year-to-date through September 30th, we resolved over $154 million of UPB of NPL loans for a total gain of $4 million. Page 11 presents our CECL loan loss reserve and loan charge-offs.

The CECL reserves in September 30th was $4.7 million or 16 bps of our outstanding loans held for investment and amortized cost balance. Our CECL reserve has been very consistent at 15 to 16 bps over the last five to six quarters. And keep in mind, the CECL loan loss reserve does not include our loans being carried at fair value. That’s the loans at amortized costs. Q3 charge-offs are also shown in the right corner on Page 11. For third quarter, they’re only $95,000. And our charge-offs have continued to be minimal over the last five to six quarters. Page 12 shows our durable funding and liquidity position at the end of Q3. Total liquidity as of September 30th was $60.3 million. That’s comprised about $29 million in cash and cash equivalents and another $31 million in available liquidity on our unfinanced collateral.

As Chris mentioned, we did issue two securitizations in Q3. In July, we issued the 2023 RTL1 security with about $81.6 million of securities being issued. Chris mentioned this is a very noteworthy security for us because it was the first security ever issued by Velocity that’s collateralized by our short-term loan product. It is a security is a fixed-rate security with the reinvestment period, where our newly originated short-term loans can be added to the security as existing loans pay off. This new type of financing for us demonstrates further diversification and financing options for Velocity, and it’s another type of cost-effective non-mark-to-market financing. In August of the quarter, we issued the 2023-3 security, collateralized by our long-term loan product, almost $235 million in securities issued.

And as Chris mentioned, in tandem with this long-term security, we collapsed one of our older securities, 2016-1, that was an older, higher-cost debt. The 2016-1 security is one of the older sequential waterfall securities, where the higher-rated low-cost tranches paid off first. So, as those things pay down, they became more expensive. Remember, in 2017, we started doing the pro rata, where the tranches all pay off kind of evenly. So, it’s nice to be able to collapse one of those securities that got more expensive over time and take that freed-up collateral, loan collateral, and bring it into the 2023-3 securitization at a lower cost. Finally, available warehouse line capacity as of September 30th was almost $595 million on total maximum line capacity of $810 million.

So, with that, I’ll turn it back over to Chris to go over the economic outlook.

Chris Farrar: Thanks Mark. On Page 13, just a high-level overview of where we’re headed. As I mentioned at the beginning, the market continues to be strong in terms of valuation and when we price REOs and assets, if they’re priced right, they move quickly, and we expect to continue to see positive gains from the portfolio there. Still a murky economic outlook with lots of different predictions and expectations, but we feel like we’re well positioned, regardless of which way things break based on our prior years’ experience in our low LTVs. I did mention that we’re starting to see prepay speeds slow. So, with that, it’ll potentially be an uptick for us in future income and help us in growing the portfolio on more scale. In terms of capital, I mentioned that we already — that we priced the last deal of the year and believe that we have good access to capital markets and expect that going forward.

And lastly, I guess, from an earnings perspective, I really think that this theme of tight credit is going to help us and be a tailwind for us as we grow going forward. So that concludes our prepared presentation, and we’d like to open it up for questions, if there are any.

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Operator: Thank you. We’ll now begin the question-and-answer session. [Operator Instructions] Your first question comes from Stephen Laws with Raymond James. Please go ahead.

Stephen Laws: Hi, good afternoon. Another nice quarter, so congratulations on that. Chris, I wanted to get an idea about your pipeline, right? October’s strongest month, I think, in a year. And I think the same for Q3 volumes for the most in, I think, four quarters. Can you talk about production outlook? Where do you see — is the October pace the new normal? Or kind of how do you think that plays out? And then any seasonality to the production numbers around year-end?

Chris Farrar: Yes, sure. So, yes, I think the fourth quarter will be our strongest quarter of the year. November is always a little light because of the holidays of Thanksgiving and whatnot. But December is always a good month for us as people try to close everything up by the end of the year. So, I think I expect it to be our strongest quarter. And then, next year, I think we’re on pace for significantly higher volumes than what we did this year. First quarter, again, January and February, just starts off a little slow, but builds. So, we think that the run rate in October is probably a touch high, if you wanted to use that on a forward run rate for every month, but not too far away from that.

Stephen Laws: Great to see the strong volumes look like they’ll continue. And can you talk about terms on these new originations? I don’t think you’re probably pushing coupon as much as you could, given less competition. But can you talk about some other places where you focus to really high-quality production on the underwriting side?

Chris Farrar: Yes, sure. Thanks Stephen. So, yes, one of the things that we are seeing is some of these borrowers come to us with a little bit larger loan sizes. We’ve been able to capitalize there, where someone coming to us with a $3 million or $4 million, $5 million loan historically would be at a bank, and we wouldn’t even get a crack at it. And we’re seeing those folks, they tend to have higher credit scores and a little stronger balance sheet. So, we put a number of those assets on here at the end of the third and start of the fourth quarter. So, we think that trend will continue as we move forward.

Stephen Laws: Great. And last one, Mark, you touched on the new securitization with the replenishment feature, the reinvest period, which sounds fantastic. And congrats on getting the last sequential pay deal done. I remember when we were first talking about those years ago and that they would eventually all delay. But can we talk about the reinvest period, the benefits of that with new production, I mean, how — what’s the expected life on loans? So, how often will that turn? And how do we think about deal expenses as we amortize those over a longer period of time, given a longer expected life? Thank you.

Mark Szczepaniak: Yes. On the short-term loans, those loans are mostly anywhere between 18 and 24-month loans. So, 18 to 24 months, the average life would be anywhere 12 to 15 months, somewhere in that range. And this is an 18-month reinvestment period, so any new loans originating as the original loans in the deal start paying off. Remember, those are interest-only, short-term interest-only loans. So, the principal is paid at maturity. So, as they’re paying off, then we can replace them with the new loan. What it helps us with is we don’t have to go to market to finance them, right? We have to go and do a whole new securitization and incur a bunch of securitization costs again just to kind of re-add them and continue to keep that financing out there.

So, that’s a big plus for us. And in terms of the deal cost, keep in mind all the loans that we’re doing now, we are applying fair value accounting to. So, on all the origination costs, and if there were deal costs, we don’t defer and amortize it anymore on the fair value loans. You have to recognize those costs upfront. And the short-term loans, we are applying fair value to just as we are in the long-term loans.

Stephen Laws: Great. Appreciate you highlighting that. I appreciate the comments this afternoon. Thank you.

Chris Farrar: Thanks Stephen.

Operator: The next question comes from Sarah Barcomb with BTIG. Please go ahead

Sarah Barcomb: Hey everyone. Congrats on the quarter and thanks for taking the question. So, you had another quarter of strong gains on those NPL resolutions. I was hoping you could give a little bit more context on your outlook for NPLs and resolutions on the NPLs. If we kind of assume that we could see another rate hike in that we’re in this higher-for-longer QT cycle, higher interest rate backdrop through next year, can you give your outlook on how that might evolve?

Chris Farrar: Yes, sure. Sarah, thanks for joining. I think we feel very good about the outlook there. There’s a lot of capital on the sidelines for these assets. And when we go to sell them either at the foreclosure steps or when we market, we see good activity, a lot of cash buyers. So, our view is that the rate hikes are not going to have a huge impact on the value of the recoveries that we’re getting right now, and we expect those to continue. I think if we saw the economy really start to tank and high unemployment and stress there, that probably would change my outlook or projection, if you will. So, I think it’s — as long as we continue to see strong economic activity, we believe that will come out very favorably there.

Sarah Barcomb: Great, okay. And then I was just thinking about next year, I was hoping you could talk a little bit more about the value and the earnings outlook for that fee-based income coming out of the Century portfolio and the value of the HUD license there. Just hoping you could kind of highlight that to investors a little bit.

Chris Farrar: Sure. Yes, we’re very excited with what’s going on there. We spent this year really building out the team and developing some muscle there. And we’ve got a great team of originators that we’ve increased, and our pipeline is very robust. So, we didn’t do a lot of loans this year, but we think next year is going to be quite robust and expect to see some very nice gain-on-sale income there, which is, from our perspective, is great because it’s high ROE, and then also build the servicing book. So, I’m very bullish on the opportunity for next year as they pull this pipeline through.

Sarah Barcomb: Great. Thanks so much for taking the questions and congrats again.

Chris Farrar: Thanks Sarah. Appreciate it.

Operator: [Operator Instructions] Your next question comes from Steve Delaney with JMP Securities. Please go ahead.

Steve Delaney: Thanks and good afternoon everyone, Chris, Mark and Chris, so curious about the bridge lending, and it’s great that you’ve got that new product working for you. Is there — I’m trying to think, at this point in the market and with rates where they are, and maybe, I guess, maybe going higher until today. Are you detecting, Chris, that there’s some sort of a rate play strategy on the part of borrowers, that if they’ve got a project underway, are they just buying time to go refi into another floater and then hope the long end comes down in the next one to two years before locking in to permanent? Just curious if there’s anything — any game and shift like that going on? Or do you think the bridge lending is more organic just in the form of new projects starting up and entrepreneurs actually, despite the environment, taking on new projects? Curious about your thoughts.

Chris Farrar: Yes, sure. It’s a good question. I think we see a lot of the former that you posed. But most of those, we end up passing on because it kind of feels to us like somebody who’s distressed or stretched in and probably not a good risk. So, we kind of pass on those. The ones that we end up doing, and we see that our most successful, are the more seasoned, experienced flippers who know their markets. And there’s still a lot of aged housing out there that needs to be rehabbed and refurbished and those are the folks that we like to bet on.

Steve Delaney: Okay. So, it’s nice to hear that activity is still running along nicely for you. Curious why — I was looking at Page 11. Maybe it’s an anomaly, but it appears that the charge-offs were down a good bit. Trying to just get a handle on why that would be necessarily, just looking at your — where you are in the third quarter versus the first two quarters of the year.

Chris Farrar: Yes. Mark, do you want to handle that one?

Mark Szczepaniak: Yes. On that one, if you recall, on our second quarter earnings call, in the $716,000 charge-off, there was $393,000 that, that charge-off probably should have been less by $393,000. There was a borrower payment that came into our servicer of $393,000 that lowers the carrying value of the loan, therefore it lowered the charge-off. But we didn’t get that information from the servicers after a closed out the quarter, and that was $393,000 — I’m sorry, it’s immaterial to our total P&L. So, we just said, well, we’ll book that recovery in Q4. So that’s what you’re seeing there, Steve. So, if you really wanted to normalize it, you’d lower the $716,000 by $393,000 and put it in Q3.

Steve Delaney: Got it. Okay. Well, thanks, I wasn’t aware of that anomaly. That makes this — no trend there. I would have been surprised if it was going down that much anyway. So — and just one final thing. Not a bit surprising, obviously, to see NPLs going up year-over-year to about 10%. Chris, I guess, when you’re looking at these situations, is there one primary cause of this? Or is it multiple? I mean the cost of carry, the first thing that comes to my mind, it’s just a heck of a lot more expensive to be a borrower these days. But we’re also running into problems with terminal fair market value of properties or the problems with borrower execution. Just curious, kind of looking back anecdotally, when you look at your set of workout loans, problem loans, is there one major dynamic that you would point to?

Chris Farrar: Yes. Good question, Steve. There’s not one dynamic that I would point to. What — I do agree with you completely that there’s a lot of cost burdens on borrowers. We’re fixed rate loans, so I think we’ve helped them in quite a bit there. But if someone’s getting behind, and they’re starting to dig a hole, it’s hard to get out of it. The interesting thing that, to me, that I would sort of add to that, or that I see out there, is I think the most significant part of that uptick — just anecdotally, I don’t have a hard data for you. But just being in the business and close to it and talking to our asset managers is, I think, we’re seeing a lot of people that were speculating get flushed out, particularly on the 1-to-4 side, peak borrowers who saw a show on TV and said, I’m going to flip some homes and found out it’s not quite as easy as they maybe thought.

So, I think we’re seeing that on the 1-to-4s. On the small commercial assets, the delinquency rates are actually lower there than they are even in the 1-to-4s, and they’re holding up extremely well. So I think it goes to, kind of, like I said, that neighborhood-serving characteristic that are still in high demand, but definitely seeing some of the speculators get washed out on the 1-to-4s.

Steve Delaney: Yes. That makes perfect sense. Well, thank you so much for the comments and great quarter — another great quarter in an extremely challenging market out there.

Chris Farrar: Thanks Steve. Appreciate it.

Mark Szczepaniak: Thanks Steve. Appreciate it.

Operator: This concludes our question-and-answer session. I’ll now hand back for any closing remarks.

Chris Farrar: Nothing further. Thank you all for joining, and we’ll talk to you next quarter.

Mark Szczepaniak: Thank you, everybody. Appreciate your time.

Operator: The conference call is now concluded. Thank you for attending. You may now disconnect.