Velocity Financial(VEL) - 2020 Q3 - Quarterly Report

PART I. FINANCIAL INFORMATION Consolidated Financial Statements (Unaudited) The unaudited consolidated financial statements for the period ended September 30, 2020, reflect the company's financial position, results of operations, changes in equity, and cash flows, highlighting the IPO, CECL adoption, and COVID-19 impacts Consolidated Balance Sheets Total assets decreased slightly to $2.13 billion as of September 30, 2020, driven by loan reclassification and reduced warehouse facilities, while stockholders' equity increased to $209.8 million due to the IPO and equity conversions Consolidated Balance Sheet Highlights (in thousands) | Account | Sep 30, 2020 (Unaudited) | Dec 31, 2019 | | :--- | :--- | :--- | | Assets | | | | Total loans, net | $2,004,413 | $2,080,787 | | - Loans held for sale, net | $0 | $214,467 | | - Loans held for investment, net | $2,001,086 | $1,863,360 | | Total assets | $2,126,866 | $2,214,766 | | Liabilities & Equity | | | | Warehouse and repurchase facilities, net | $19,541 | $421,548 | | Securitizations, net | $1,670,930 | $1,438,629 | | Total liabilities | $1,827,106 | $2,061,922 | | Mezzanine Equity (Preferred Stock) | $90,000 | $0 | | Total stockholders' / members' equity | $209,760 | $152,844 | | Total liabilities, mezzanine equity and stockholders' / members' equity | $2,126,866 | $2,214,766 | Consolidated Statements of Income Net income decreased to $3.5 million in Q3 2020 and $8.2 million for the nine months, primarily due to higher loan loss provisions and increased operating expenses, leading to a $40.8 million net loss allocated to common shareholders for the nine-month period Statement of Income Summary (in thousands, except per share data) | Metric | Q3 2020 | Q3 2019 | Nine Months 2020 | Nine Months 2019 | | :--- | :--- | :--- | :--- | :--- | | Net interest income | $17,114 | $14,710 | $49,233 | $41,645 | | Provision for loan losses | $1,573 | $338 | $4,662 | $898 | | Total operating expenses | $11,865 | $8,484 | $34,823 | $25,308 | | Net income | $3,481 | $3,880 | $8,201 | $12,110 | | Less deemed dividends on preferred stock | $0 | N/A | $48,955 | N/A | | Net income (loss) allocated to common shareholders | $3,481 | N/A | $(40,754) | N/A | | Basic EPS | $0.17 | N/A | $(2.03) | N/A | | Diluted EPS | $0.11 | N/A | $(2.03) | N/A | Consolidated Statements of Cash Flows For the nine months ended September 30, 2020, cash decreased by $0.5 million, with operating activities providing $37.4 million, investing activities providing $73.3 million, and financing activities using $111.2 million Cash Flow Summary (Nine Months Ended Sep 30, in thousands) | Activity | 2020 | 2019 | | :--- | :--- | :--- | | Net cash provided by (used in) operating activities | $37,364 | $(77,193) | | Net cash provided by (used in) investing activities | $73,339 | $(219,034) | | Net cash (used in) provided by financing activities | $(111,224) | $291,551 | | Net decrease in cash | $(521) | $(4,676) | Notes to Unaudited Consolidated Financial Statements The notes detail significant events and accounting policies, including the company's IPO, CECL adoption, COVID-19 forbearance impact, transfer of held-for-sale loans, and issuance of convertible preferred stock - On January 16, 2020, the company converted from an LLC to a corporation, and on January 22, 2020, it completed its IPO of 7,250,000 shares at $13.00 per share[27] - The company adopted the CECL (ASU 2016-13) accounting standard on January 1, 2020, resulting in a $96,000 decrease to retained earnings. The CECL estimate for September 30, 2020, used a COVID-19 stress scenario with a five-quarter forecast period[38][44][52] - Effective July 1, 2020, the entire loans held for sale portfolio, with a UPB of $214.4 million, was transferred to the held for investment portfolio[59] - As of September 30, 2020, loans with a UPB of $411.2 million had participated in the COVID-19 forbearance program. Of these, approximately 81% ($335.1 million) were subsequently brought current[60][56] - In April 2020, the company issued 45,000 shares of Series A Convertible Preferred Stock and warrants, resulting in net proceeds of $43.2 million. This preferred stock is recorded as mezzanine equity[98][105] Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) The MD&A details the company's business, operational results, and financial condition, focusing on COVID-19 impacts, management strategies, increased nonperforming loans, higher credit loss provisions, and bolstered liquidity from IPO and private placement Business and Recent Developments Velocity Financial, a real estate finance company, was significantly impacted by COVID-19, leading to suspended originations, a forbearance program, capital raising, and workforce reductions upon resuming operations - The company's loan portfolio totaled $2.0 billion in UPB as of September 30, 2020, with a weighted average LTV of 66.2%[134] - In response to COVID-19, the company temporarily suspended loan originations, furloughed staff, implemented a loan forbearance program, and raised $45.0 million in gross proceeds from issuing Preferred Stock and Warrants[145] - Loan originations resumed in September 2020, with over $220 million in applications received during the month. The company also reduced its workforce by 60 employees to improve cost efficiency[143] Portfolio and Asset Quality The loan portfolio totaled $2.0 billion, with nonperforming loans significantly increasing to 15.8% due to COVID-19, and the allowance for credit losses rising to $5.7 million reflecting CECL adoption and portfolio reclassification Key Portfolio Statistics (UPB in thousands) | Metric | Sep 30, 2020 | Dec 31, 2019 | | :--- | :--- | :--- | | Total loans (UPB) | $1,986,344 | $2,059,344 | | Weighted average LTV | 66.2% | 65.8% | | Weighted average coupon | 8.56% | 8.69% | | Nonperforming loans (UPB) | $314,727 | $141,607 | | Nonperforming loans (% of total) | 15.84% | 6.88% | - Loan originations were suspended from late March through August 2020. In September 2020, the company resumed originations, closing $8.1 million in new loans[178] - The allowance for credit losses increased to 0.29% of loans held for investment (excluding FVO) as of September 30, 2020, compared to 0.12% as of September 30, 2019, primarily due to the impact of COVID-19 and the transfer of the HFS portfolio[183] Consolidated Results of Operations Net income declined in Q3 2020 and for the nine-month period, primarily due to increased provision for loan losses and higher operating expenses, including expensed origination costs from production suspension Results of Operations Comparison (in thousands) | Metric | Q3 2020 | Q3 2019 | Nine Months 2020 | Nine Months 2019 | | :--- | :--- | :--- | :--- | :--- | | Net interest income | $17,114 | $14,710 | $49,233 | $41,645 | | Provision for loan losses | $1,573 | $338 | $4,662 | $898 | | Total operating expenses | $11,865 | $8,484 | $34,823 | $25,308 | | Net income | $3,481 | $3,880 | $8,201 | $12,110 | - The provision for loan losses for Q3 2020 included a $1.2 million impact from transferring the held-for-sale portfolio to held-for-investment. This was largely offset by a $1.3 million reversal of the valuation allowance on those loans, recorded in 'Other operating income'[251][184] - Compensation expenses increased by $2.0 million in Q3 2020 vs Q3 2019, primarily because direct origination costs were expensed in 2020 due to the production suspension, whereas they were deferred in 2019. A one-time severance payment of $0.6 million also contributed to the increase[254][255] Liquidity and Capital Resources Liquidity was actively managed through IPO and preferred stock proceeds, used to pay down debt and reduce warehouse borrowings, with $19.2 million in cash and three securitizations totaling over $666 million completed - Primary sources of liquidity are warehouse facilities, securitizations, corporate debt, and equity. In 2020, the company raised capital via its IPO ($100.8 million net proceeds) and a preferred stock/warrant issuance ($41.0 million net proceeds)[263][267] - The company completed three securitizations in 2020 (2020-1, 2020-2, 2020-MC1), securitizing a total of $666.3 million in mortgage loans and issuing $524.4 million in securities[276] - As of September 30, 2020, outstanding borrowings under warehouse and repurchase facilities were significantly reduced to $19.8 million (gross) from much higher levels at year-end 2019[282][269] Controls and Procedures Disclosure controls were effective, but a material weakness in internal control over financial reporting related to income tax accounting persists, despite an ongoing remediation plan - A material weakness related to the accounting for a 2018 tax election, identified in the 2019 10-K, remains as of September 30, 2020[290] - A remediation plan is in place, involving a nationally recognized accounting firm to supplement and train the accounting team and implement new internal controls over income tax processes[290] - Despite the material weakness, management concluded that disclosure controls and procedures were effective at a reasonable assurance level and that the financial statements are fairly presented in all material respects[291] PART II. OTHER INFORMATION Legal Proceedings The company is involved in various legal proceedings, including a class action complaint filed on July 9, 2020, alleging securities law violations related to its January 2020 IPO, which the company intends to vigorously defend - A class action complaint was filed on July 9, 2020, alleging violations of securities laws related to the company's January 2020 IPO[296] - The complaint seeks unspecified damages and legal costs. The company plans to vigorously defend against the action[296]