Good afternoon and welcome to the Velocity Financial Incorporated Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Mr. Chris Oltmann, Chief Accounting Officer. Please go ahead.

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 Szczepaniak, 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 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 a 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.

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, experienced favorable trends and 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 insights 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. Team is very proud of the business…

Thanks, Chris. Good afternoon and good evening, everybody. On Page 5 of the deck, really shows how the loan production momentum has continued to build going from $179 million in Q4 to $233 million, to over $256 million for 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 and forth for last year, we were holding back on the short-term products. 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 in 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 $1 billion 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 6, 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 just 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 66% LTV, so nice strong growth coming through and holding that LTV consistent. On Page 7 portfolio type of margin is its generating, for Q2…

Great. Thank you, Mark. I appreciate it. On 11, 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 disseminating information, and getting the info out to them to let them know that those that assistance is available. So I 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 in the portfolio, growing earnings, obviously, by growing the portfolio, we see good demand across all product types. We're that 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 this next securitization, and then another one here, and probably in Q4, we 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 we should be in a nice tailwind for us, which is in the warehouse line. On 12, this is a new slide for us. And 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…

Thank you. We will now begin the question-and-answer session. The first question comes from Steve DeLaney with the JMP Securities. Please go ahead.

Hello, everyone. Hope you're doing well and staying safe. Great, great quarter. 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 loans held for sale and whole loan format? And I think you did about $15 million, was a $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.

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 securitization exit in the works for those. We certainly would 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 upfront. And then, on the back end, we were making an interest spread. So, I mean, all in, if you wanted to figure something, you can probably figure like 103.5 to 104 price. But our hope is that we are 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.

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 the NPL and some of the recoveries. In your mind, as you model it out, and I don't know if Mark has built sort of 2022 models yet. But do you have any sense for looking at the - the loan yields seem crazy sticky, 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 4.83% in the second quarter? Do you have a target?

Yeah, thank you. I think we're not kind of putting out official guidance, but we think that the right number to use is probably what - it's somewhere between Q1 and Q2. I think Q2 is a little elevated. And again, if we get 5 or 6 loans that cure that it's been delinquent for 15 months, you get all this interest in one quarter, right?

Yeah, yeah.

So, that's why we were kind of trying to warn.

Lumpy.

Lumpiness, yeah. So I think it's somewhere between the those 2. I mean, if I would probably say, it points you more towards like the 4%, 4.25% range. It's probably where we'll model NIM now. That's before the corporate debt. That's just on the…

Oh, sure, that's portfolio with everything else, yeah.

Yeah, yeah.

Okay, great. Well, thanks for that. I'll leave some other stuff for the rest of the guys on the line. But thanks for your comments. Bye.

Thank you, Steve.

Thank you. Our next question comes from Stephen Laws with Raymond James. Please go ahead.

Hi, good afternoon, Chris, Chris and Mark. As Steve said, great hearing from you. And congrats, you guys have really accomplished a lot in the last, yeah, 15 months from where we are, I think about a year ago. It really positive outlook, I think, Steve covered a good bit on the origination side with the prepared remarks. Can you maybe spend a little more time on the cost of funds seems like big opportunity there, I know, you're looking at collapsing a couple of deals? Can you try to quantify that for us, 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 6 or 9 months where it'll accelerate lower?

Mark, do you want to try to hit that one?

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 a 5% to 6% overall cost of funds handle. And we think with refinancing, re-leveraging these in new securitizations that we could bring that cost of funds into somewhere in the 2 handle, so pretty nice pick up on that.

Yeah, thanks for that color. And, thinking about the origination business, you mentioned in the prepared remarks about own pace kind of trending for about $1 billion a year at $104 million in July. With your current platform and scale, where can that number go? Is there still significant opportunity on the upside as far as a monthly volume? Are we kind of a good pace now to see the business?

Yeah, I think there's definitely room to go. We want to grow 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 think there's expect higher volumes next year, and I think that there's plenty of room to run there.

Great. Thanks for the comments, Chris. Appreciate your time this afternoon.

You're welcome. Thank you.

Stephen, one thing to keep in mind is we hit the billion dollars in 2019 that was offering the short-term products pretty much most of the year. And we're already almost halfway to $1 billion for 6 months of this year. And we just started offering the short-term product and reintroducing it the last quarter. So…

Where would you like to see that, that gives you, I think you said $15 million? Is there any kind of target maybe even quarterly run rate next year on that product?

Yeah, 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. So…

Yeah, the opportunity to really grow volumes next year then. Great. Thanks for that additional color, Mark. Appreciate it.

Thank you. Our next question comes from Arren Cyganovich with Citi. Please go ahead.

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 more kind of normal levels that like half that or just trying to frame out?

Hey, Arren, this is Mark. Yeah, $7 million was the actual cash received in Q2 related to nonperforming loans where we had already taken the interest income off our books, because once the loan goes nonperforming, we reverse out all the interest income and put it on nonaccrual. And then, we wait for the actual resolution of the cash to come into rebook that income. So $7 million was actual cash that came in that was passed do contractual interest that came in second quarter. Remember, we charge a 4% default rate, was the default interest to come - 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 was to be prepayments fees as well. So the $7 million was all cash that came in on nonperforming loans. I think, it 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 since at least I know the company in terms of nonperforming resolution cash. And it's very hard to predict, because we don't book it until we get the cash and 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 gains going to come through in cash and book it on a cash basis, it's really hard to predict that.

Yeah, I understand. That's helpful. The other question I had was on a new nonperforming loan formation. Clearly, you've resolved quite a few loans for the quarter. But you also had some new additions, is the new addition there, the pace of new additions that are coming in nonperforming beginning to slow or what are your views on that front?

Yeah, we do see that slowing the majority of those loans are folks that were in some type of COVID forbearance, and they're failing, they're just not making it. So, I think, from that perspective, we're encouraged, that is not new originations or newer borrowers, mostly driven by folks that are already struggling. So I think that's why you see the offset. And that's why we've been telling everyone is going to take time to kind of work through this whole backlog and as these borrowers deal with their reality, and figure out how to get resolved. So it's mostly forbearance loans that we're incorporating.

Okay. All right. Thank you.

Yeah. Thank you, Arren.

Your next question comes from Don Fandetti with Wells Fargo. Please go ahead.

Hi, I guess, a couple of questions. One, Chris, just checking in on the competitive dynamic. It sounds - it seems like your business has largely been very fragmented smaller private lenders. 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?

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 with some - and one I can think, in particular, as a private REIT that's been aggressively acquiring assets. And so, we agreed to be their financial partner, but not necessarily a JV with another institution. But, by and large, the majority of the business is still coming through our brokers. And that's really where we're seeing the growth.

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 that to grow faster than the Investor 1-4 Rental.

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 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 2 product types.

Got it. Okay. Thanks .

Sure.

This concludes our question-and-answer session. I would like to turn the conference back over to Chris Farrar, for any closing remarks.

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.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.