VELOCITY FINANCIAL, INC. The following discussion and analysis of our financial condition and results of operations should be read together with "Item 6. Selected Financial Data" and the consolidated financial statements and related notes and the other financial information included elsewhere in the Annual Report on Form 10-K. This discussion contains forward-looking statements, as described under the heading "Forward-Looking Statements" that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and elsewhere in this prospectus, particularly under "Item 1A. Risk Factors."
Business
We are a vertically integrated real estate finance company founded in 2004. We primarily originate and manage investor loans secured by 1-4 unit residential rental and small commercial properties, which we refer to collectively as investor real estate loans. We originate loans nationwide across our extensive network of independent mortgage brokers which we have built and refined over the 15 years since our inception. Our objective is to be the preferred and one of the most recognized brands in our core market, particularly within our network of mortgage brokers. We operate in a large and highly fragmented market with substantial demand for financing and limited supply of institutional financing alternatives. We have developed the highly-specialized skill set required to effectively compete in this market, which we believe has afforded us a durable business model capable of generating compelling risk-adjusted returns for our stockholders throughout various business cycles. We offer competitive pricing to our borrowers by pursuing low-cost financing strategies and by driving front- end process efficiencies through customized technology designed to control the cost of originating a loan. Furthermore, by originating loans through our efficient and scalable network of approved mortgage brokers, we are able to maintain a wide geographical presence and nimble operating infrastructure capable of reacting quickly to changing market environments. Our growth strategy is predicated on continuing to serve and build loyalty within our network of mortgage brokers, while also expanding our network with new mortgage brokers through targeted marketing, improved brand awareness, and the growth and development of our team of account executives. We believe our reputation and 15-year history within our core market position us well to capture future growth opportunities. Our primary source of revenue is interest income earned on our loan portfolio. Our typical loan is secured by a first lien on the underlying property with a personal guarantee and, based on all loans in our portfolio as ofDecember 31, 2019 , has an average balance of approximately$323,000 . As ofDecember 31, 2019 , our loan portfolio, including both loans held for investment and loans held for sale, totaled$2.1 billion of UPB on properties in 45 states and theDistrict of Columbia . The total portfolio had a weighted average loan-to-value ratio, or LTV at origination, of 65.8%, and was concentrated in 1-4 unit residential rental loans, which we refer to as investor 1-4 loans, representing 52.2% of the UPB. During the year endedDecember 31, 2019 , the yield on our total portfolio was 8.84%. We fund our portfolio primarily through a combination of committed and uncommitted secured warehouse repurchase facilities, securitizations, corporate debt and equity. The securitization market is our primary source of long-term financing. We have successfully executed twelve securitizations, resulting in a total of over$2.5 billion in gross debt proceeds fromMay 2011 throughOctober 2019 . InJanuary 2020 , we repaid$75.0 million of our existing corporate debt with a portion of the net proceeds from our IPO. InFebruary 2020 , we completed the securitization of$261.9 million of investor real estate loans, measured by UPB as of theJanuary 1, 2020 cut-off date, issuing$248.7million of non-recourse notes payable through theVelocity Commercial Capital Loan Trust 2020-1, or 2020-1. We are the sole beneficial interest holder of 2020-1, a variable interest entity that will be included in our consolidated financial statements. We refer to this transaction as the "February 2020 Securitization." One of our core profitably measurements is our portfolio related net interest margin, which measures the difference between interest income earned on our loan portfolio and interest expense paid on our portfolio-related debt, relative to the amount of loans outstanding over the period. Our portfolio-related debt consists of our warehouse repurchase facilities and securitizations and excludes our corporate debt. For the year endedDecember 31, 2019 , our portfolio related net interest margin was 4.13%. We generate profits to the extent that our portfolio related net interest income exceeds our interest expense on corporate debt, provision for loan losses and operating expenses. For the year endedDecember 31, 2019 , we generated income before income taxes and net income of$25.4 million and$17.3 million , respectively, and earned a pre-tax return on equity and return on equity of 17.4% and 11.8%, respectively. 40 --------------------------------------------------------------------------------
Items Affecting Comparability of Results
Due to a number of factors, our historical financial results may not be comparable, either from period to period, or to our financial results in future periods. We have summarized the key factors affecting the comparability of our financial results below. Income Taxes Prior to our initial public offering, the Company operated asVelocity Financial, LLC , which was formed as aDelaware Limited Liability Company , or LLC, in 2012. UntilJanuary 1, 2018 , as an LLC, we had elected to be treated as a partnership forU.S. federal and state income tax purposes, and as such, had generally not been subject to federal and state income taxes prior toJanuary 1, 2018 . Accordingly, the results of operations presented for the years prior toJanuary 1, 2018 do not include any provision for federal or state income taxes. As part of our initial public offering, we convertedVelocity Financial, LLC into aDelaware corporation and changed our name toVelocity Financial, Inc. , a transaction that we refer to as the "conversion" in this Annual Report Form 10-K. The conversion is accounted for in accordance with ASC 805-50 -Business Combinations, as a transaction between entities under common control. The conversion is not expected to impact our provision for income taxes or our deferred tax assets and liabilities. EffectiveJanuary 1, 2018 , we elected to be treated as a corporation forU.S. federal and state income tax purposes. Accordingly, the results of operations for the year endedDecember 31, 2018 include the impacts of income taxes. As a result, the historical net income reported for any period prior toJanuary 1, 2018 , is not comparable to the net income reported for the year endedDecember 31, 2018 or the net income anticipated in future periods. Furthermore, in connection with the new tax treatment, we began recognizing, and will continue to recognize, deferred tax assets and liabilities for future tax consequences attributable to differences between the financial statement carrying amounts of our existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using the tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the statements of operations in the period that included the enactment date, as applicable.
Interest Expense on Corporate Debt
In 2014, we entered into a five-year,$100.0 million corporate debt agreement with the owners of our Class C preferred units, pursuant to which we issued at par senior secured notes, the 2014 Senior Secured Notes, that mature onDecember 16, 2019 . The 2014 Senior Secured Notes bear interest, at our election, at either 10% annually paid in cash or 11% annually paid in kind. InAugust 2019 , we entered into a five-year$153.0 million corporate debt agreement with Owl Rock Capital Corporation ("2019 Term Loans"). The 2019 Term Loans under this agreement bear interest at a rate equal to one-month LIBOR plus 7.50% and mature inAugust 2024 . A portion of the net proceeds from the 2019 Term Loans was used to redeem all of the outstanding 2014 Senior Secured Notes inAugust 2019 . Another portion of the net proceeds from the 2019 Term Loans, together with cash on hand, was used to repurchase our outstanding Class C preferred units. As ofDecember 31, 2018 , including paid-in-kind interest, the 2014 Senior Secured Notes balance was$127.6 million , and is presented as secured financing, net of debt issuance costs, on the consolidated statement of financial condition. The 2019 Term Loans balance was$153.0 million as ofDecember 31, 2019 . During the year endedDecember 31, 2019 , we incurred$14.6 million of interest expense related to the 2014 Senior Secured Notes and the 2019 Term Loans. We used$75.7 million of the net proceeds from our IPO to lower our interest expense through the repayment of the$75.0 million outstanding principal amount on the 2019 Term Loans. 41
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Recent DevelopmentsJanuary 2020 IPO OnJanuary 16, 2020 ,Velocity Financial, LLC converted from aDelaware limited liability company to aDelaware corporation and changed its name toVelocity Financial, Inc. The Conversion was accounted for in accordance with ASC 805-50 -Business Combinations, as a transaction between entities under common control. All assets and liabilities ofVelocity Financial, LLC were contributed toVelocity Financial, Inc. at their carrying value. The Conversion had no impact on our provision for income taxes or our deferred tax assets and liabilities. Upon completion of the Conversion,Velocity Financial, LLC's Class A equity units of 97,513,533 and Class D equity units of 60,193,989 were converted to 11,749,994 shares ofVelocity Financial, Inc. common stock. OnJanuary 22, 2020 , we completed our initial public offering ("IPO"). The net proceeds received from the sale of our common stock in the IPO was$100.7 million , including$13.1 million from the underwriters fully exercising their over-allotment option to purchase an additional 1,087,500 shares of our common stock. The proceeds were net of underwriting discounts and commissions and offering expenses payable by us. We used$75.7 million of the net proceeds from our IPO to repay$75.0 million principal amount of our outstanding 2019 Term Loans described below (plus$0.7 million for related prepayment penalties and accrued interest), and the remainder for general corporate purposes, including originating or acquiring investor real estate loans. The 2019 Term Loans bear interest at a rate equal to one-month LIBOR plus 7.50% and mature inAugust 2024 .
Strategies to Address Uncertainties Caused by COVID-19
The COVID-19 outbreak has caused significant disruption in business activity and the financial markets both globally and inthe United States . As a result of the spread of COVID-19, economic uncertainties have arisen which are likely to negatively impact our financial condition, results of operations and cash flows. The extent of the impact of COVID-19 on our operational and financial performance will depend on certain developments, including the duration and spread of the outbreak and impact on our customers, employees and vendors, all of which is uncertain at this time and cannot be predicted. The extent to which COVID-19 may impact our financial condition or results of operations cannot be reasonably estimated at this time. For more information on the potential impacts of the COVID-19 outbreak on our business see "Item 1A. Risk Factors-The outbreak of the recent coronavirus, COVID-19, or an outbreak of another highly infectious or contagious disease, could adversely affect our business, financial condition, results of operations and cash flow, and limit our ability to obtain additional financing." We have proactively executed a number of business initiatives to strengthen our liquidity position and re-focus our business strategies in light of the effects of the COVID-19 pandemic, including the following:
• On
Series A Convertible Preferred Stock, par value
"Preferred Stock"), in a private placement to affiliates of
and TOBI (the "Purchasers"), our two largest common stockholders, at a
price per share of Preferred Stock of
private placement, we issued and sold to the Purchasers warrants (the
"Warrants") to purchase an aggregate of 3,013,125 shares of our common
stock. This private placement offering resulted in gross proceeds to us of
million. We intend to use the net proceeds from this private placement to
pay down our existing warehouse repurchase facilities and general
corporate purposes. See "Note 24 - Subsequent Events" in the consolidated
financial statements included in this Annual Report for information about
the Preferred Stock and the Warrants. We will evaluate the Preferred Stock
and the Warrants for liability or equity classification in accordance with
the provisions of ASC 480, Distinguishing Liabilities from Equity.
• On
agreements on both of our warehouse repurchase agreements with the lenders
under such agreements. We believe that the amended warehouse repurchase
agreements provide us with a flexible and more stabilized financing
solution that will allow us to better operate our business under the
current market conditions. For more information about the amended
warehouse repurchase agreements see "-Liquidity and Capital
Resources-Warehouse Repurchase Facilities" below.
42
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• During this economic crisis, we will consider the benefits of originating
commercial mortgage loans along with opportunistically acquiring
commercial mortgage loans that comply with our credit guidelines. If we
are able to prudently originate or acquire mortgage loans, they will be
added to our held for investment loan portfolio and supplement our current
earnings profile generated by our
are primarily fixed rate loans financed with fixed rate securitizations.
We will continue to evaluate our business strategy in light of rapidly
changing market conditions.
Critical Accounting Policies and Use of Estimates
The preparation of financial statements in accordance withU.S. GAAP requires certain judgments and assumptions, based on information available at the time of preparation of the consolidated financial statements, in determining accounting estimates used in preparation of the consolidated financial statements. The following discussion addresses the accounting policies that we believe apply to us based on the nature of our operations. Our most critical accounting policies involve decisions and assessments that could affect our reported assets and liabilities, as well as our reported revenues and expenses. We believe that all of the decisions and assessments used to prepare the company's financial statements are based upon reasonable assumptions given the information available at that time. We believe the following are critical accounting policies that require the most significant judgments and estimates used in the preparation of the consolidated financial statements. The summary below should be read in conjunction with the disclosure of our accounting policies and use of estimates in Note 2 to the consolidated financial statements.
Allowance for Loan Losses
The allowance for loan and lease losses, or ALLL, on loans held for investment is maintained at a level deemed adequate by management to provide for probable and inherent losses in the portfolio at the balance sheet date. The ALLL has a general reserve component for loans with no credit impairment and a specific reserve component for loans determined to be impaired. The allowance methodology for the general reserve component includes both quantitative and qualitative loss factors which are applied to the population of unimpaired loans to estimate the general reserves. The quantitative loss factors include loan type, age of the loan, borrower FICO score, past loan loss experience, historical default rates, and delinquencies. The qualitative loss factors consider, among other things, the loan portfolio composition and risk, current economic conditions that may affect the borrower's ability to pay, and the underlying collateral value. While our management uses available information to estimate its required ALLL, future additions to the ALLL may be necessary based on changes in estimates resulting from economic and other conditions. The provision for loan losses and recoveries of previously recognized charge-offs are added to the ALLL, while charge-offs on loans are recorded as a reduction to ALLL. Loans are considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal and interest according to the contractual terms of the loan agreements. Impairment is measured on a loan-by-loan basis by comparing the estimated fair value of the underlying collateral, net of estimated selling costs (net realizable value) against the recorded investment of the loan. To the extent the recorded investment of the loan exceeds the estimated fair value, a specific reserve or charge-off is recorded depending upon either the certainty of the estimate of loss or the fair value of the loan's collateral.
Deferred Income Tax Assets and Liabilities
Our deferred income tax assets and liabilities arise from differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. We
determine whether a deferred tax asset is realizable based on facts and
circumstances, including our current and projected future tax position, the
historical level of our taxable income, and estimates of our future taxable
income. In most cases, the realization of deferred tax assets is based on our
future profitability. If we were to experience either reduced profitability or
operating losses in a future period,
43
--------------------------------------------------------------------------------the realization of our deferred tax assets may no longer be considered more likely than not and, accordingly, we could be required to record a valuation allowance on our deferred tax assets by charging earnings.
How We Assess Our Business Performance
Net income is the primary metric by which we assess our business performance. Accordingly, we closely monitor the primary drivers of net income which consist of the following: Net Interest Income Net interest income is the largest contributor to our net income and is monitored on both an absolute basis and relative to provisions for loan losses and operating expenses. We generate net interest income to the extent that the rate at which we lend in our portfolio exceeds the cost of financing our portfolio, which we primarily achieve through long-term securitizations. Accordingly, we closely monitor the financing markets and maintain consistent dialogue with investors and financial institutions as we evaluate our financing sources and cost of funds. To evaluate net interest income, we measure and monitor: (1) the yields on our loans, (2) the costs of our funding sources, (3) our net interest spread and (4) our net interest margin. Net interest spread measures the difference between the rates earned on our loans and the rates paid on our funding sources. Net interest margin measures the difference between our annualized interest income and annualized interest expense, or net interest income, as a percentage of average loans outstanding over the specified time period. Periodic changes in net interest income are primarily driven by: (1) origination volume and changes in average outstanding loan balances and (2) interest rates and changes in interest earned on our portfolio or paid on our debt. Historically, origination volume and portfolio size have been the largest contributors to the growth in our net interest income. We measure net interest income before and after interest expense related to our corporate debt and before and after our provisions for loan losses.
Credit Losses
We strive to minimize actual credit losses through our rigorous screening and underwriting process and life of loan portfolio management and special servicing practices. We closely monitor the credit performance of our loan portfolio, including delinquency rates and expected and actual credit losses, as a key factor in assessing our overall business performance.
Operating Expenses
We incur operating expenses from compensation and benefits related to our employee base, rent and other occupancy costs associated with our leased facilities, our third-party primary loan servicing vendors, professional fees to the extent we utilize third-party legal, consulting and advisory firms, and costs associated with the resolution and disposition of real estate owned, among other items. We monitor and strive to prudently manage operating expenses and to balance current period profitability with investment in the continued development of our platform. Because volume and portfolio size determine the magnitude of the impact of each of the above factors on our earnings, we also closely monitor origination volume along with all key terms of new loan originations, such as interest rates, loan-to-value ratios, estimated credit losses and expected duration.
Factors Affecting Our Results of Operations
We believe there are a number of factors that impact our business, including those discussed below and in this Form 10K titled "Item 1A Risk Factors."
Our results of operations depend on, among other things, the level of our net
interest income, the credit performance of our loan portfolio and the efficiency
of our operating platform. These measures are affected by a number of factors,
including the demand for investor real estate loans, the competitiveness of the
market for originating or acquiring investor real estate loans, the cost of
financing our portfolio, the availability of funding
44
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sources and the underlying performance of the collateral supporting our loans.
While we have been successful at managing these elements in the past, there are
certain circumstances beyond our control, including the current disruption
caused by the COVID-19 pandemic, macroeconomic conditions and market
fundamentals, which can affect each of these factors and potentially impact our
business performance.
Origination Volume
Portfolio related net interest income is the largest contributor to our net
income. We have grown our portfolio related net interest income by $11.5 million
or 18.5% from $62.1 million for the year ended December 31, 2018 to $73.6
million for the year ended December 31, 2019 . Our portfolio related net interest
income grew by $11.9 million or 23.8% from $50.2 million for the year ended
December 31, 2018 to $62.1 million for the year ended December 31, 2018 . The
growth in net interest income is largely attributable to our growth in loan
originations which we have achieved by executing our principal strategies of
expanding our broker network and further penetrating our network of existing
brokers. We anticipate that our future performance will continue to depend on
growing our origination volume and believe that the large and highly fragmented
nature of our core market provides meaningful opportunity to achieve this. We
intend to grow originations by continuing to serve and build loyalty within our
existing network of brokers while expanding our network with new brokers through
targeted marketing and improved brand awareness.
Our future performance could be impacted to the extent that our origination
volumes decline as we rely on new loans to offset maturities and prepayments in
our existing portfolio. To augment our core origination business, we continually
assess opportunities to acquire portfolios of loans that meet our investment
criteria. In our experience, portfolio acquisition opportunities have generally
been more attractive and plentiful during market conditions when origination
opportunities are less favorable. Accordingly, we believe our acquisition
strategy not only expands our core business, but also provides a
counter-cyclical benefit.
Competition
The investor real estate loan market is highly competitive which could affect our profitability and growth. We believe we compete favorably through diversified borrower access driven by our extensive network of mortgage brokers and by emphasizing a high level of real estate and financial expertise, customer service, and flexibility in structuring transactions, as well as by attracting and retaining experienced managerial and marketing personnel. However, some of our competitors may be better positioned to market their services and financing programs because of their ability to offer more favorable rates and terms and other services.
Availability and Cost of Funding
Our primary funding sources have historically included cash from operations, warehouse repurchase facilities, term securitizations, corporate debt and equity. We believe we have an established brand in the term securitization market and that this market will continue to support our portfolio growth with long-term financing. Changes in macroeconomic conditions can adversely impact our ability to issue securitizations and, thereby, limit our options for long-term financing. In consideration of this potential risk, we have entered into a credit facility for longer-term financing that will provide us with capital resources to fund loan growth in the event we are not able to issue securitizations. We used$75.7 million of the net proceeds from our IPO to lower our interest expense through the repayment of$75.0 million in outstanding principal amount on the 2019 Term Loans. Loan Performance We underwrite and structure our loans to minimize potential losses. We believe our fully amortizing loan structures and avoidance of large balloon payments, coupled with meaningful borrower equity in properties, limit the probability of losses and that our proven in-house asset management capability allows us to minimize potential losses in situations where there is insufficient equity in the property. Our income is highly dependent upon 45 -------------------------------------------------------------------------------- borrowers making their payments and resolving delinquent loans as favorably as possible. Macroeconomic conditions can, however, impact credit trends in our core market and have an adverse impact on financial results.
Macroeconomic Conditions
The investor real estate loan market may be impacted by a wide range of macroeconomic factors such as interest rates, residential and commercial real estate prices, home ownership and unemployment rates, and availability of credit, among others. We believe our prudent underwriting, conservative loan structures and interest rate protections, and proven in-house asset management capability leave us well positioned to manage changing macroeconomic conditions.
Operating Efficiency
We generate positive operating leverage to the extent that our revenue grows at
a faster rate than our expenses. We believe our platform is highly scalable and
that we can generate positive operating leverage in future periods, primarily
due to the technology and other investments we have made in our platform to date
and our focus on a scalable, cost-effective mortgage broker network to generate
new loan originations.
Portfolio and Asset Quality
Key Portfolio Statistics
December 31,
2019 2018 2017
($ in thousands)
Total loans $ 2,059,344 $ 1,631,326 $ 1,295,567
Loan count 6,373 5,171 4,136.00
Average loan balance $ 323 $ 315 $ 313
Weighted average loan-to-value 65.8 % 63.8 % 64.4 %
Weighted average coupon 8.69 % 8.56 % 8.33 %
Nonperforming loans (UPB) $ 141,607 $ 95,385 $ 74,943
Nonperforming loans (% of total) 6.88 % 5.85 % 5.78 %
Total Loans. Total loans reflects the aggregate UPB at the end of the period. It excludes deferred origination costs, acquisition discounts, fair value adjustments and allowance for loan losses.
Loan Count. Loan count reflects the number of loans at the end of the period. It includes all loans with an outstanding principal balance.
Average Loan Balance. Average loan balance reflects the average UPB at the end of the period (i.e., total loans divided by loan count).
Weighted Average Loan-to-Value. Loan-to-value, or LTV, reflects the ratio of
the original loan amount to the appraised value of the underlying property at
the time of origination. In instances where the LTV at origination is not
available for an acquired loan, the LTV reflects our best estimate of value at
the time of acquisition. Weighted average LTV is calculated for the population
of loans outstanding at the end of each specified period using the original loan
amounts and appraised LTVs at the time of origination of each loan. LTV is a key
statistic because requiring the borrower to invest more equity in the collateral
minimizes our exposure for future credit losses.
Nonperforming Loans. Loans that are 90 or more days past due, in bankruptcy, or
in foreclosure are not accruing interest and are considered nonperforming loans.
The dollar amount of nonperforming loans presented in the table above reflects
the UPB of all loans that meet this definition.
46
--------------------------------------------------------------------------------Originations and Acquisitions
The following table presents new loan originations and acquisitions and includes
average loan size, weighted average coupon and weighted average loan-to-value
for the periods indicated:
Weighted Weighted
Average Average Average
($ in thousands) Loan Count Loan Balance Loan Size Coupon LTV
Year Ended December 31, 2019 :
Loan originations - held for
investment 1,881 $ 673,877 $ 358 8.5 % 67.1 %
Loan originations - held for
sale 1,152 $ 338,846 $ 294 10.0 % 68.4 %
Total loan originations 3,033 $ 1,012,723 $ 334 9.0 % 67.5 %
Loan acquisitions - held for
investment 35 $ 9,062 $ 259 7.2 % 61.9 %
Total loans originated and
acquired 3,068 $ 1,021,785
Year Ended December 31, 2018 :
Loan originations - held for
investment 1,708 $ 587,241 $ 344 8.4 % 63.4 %
Loan originations - held for
sale 619 $ 150,056 $ 242 9.9 % 65.1 %
Total loan originations 2,327 $ 737,297 $ 317 8.7 % 63.8 %
Loan acquisitions - held for
investment 19 $ 16,243 $ 855 7.3 % 53.5 %
Total loans originated and
acquired 2,346 $ 753,540
Year Ended December 31, 2017 :
Loan originations - held for
investment 1,630 $ 511,284 $ 314 8.4 % 64.3 %
Loan originations - held for
sale 176 $ 43,426 $ 247 9.6 % 69.7 %
Total loan originations 1,806 $ 554,710 $ 307 8.5 % 64.7 %
Loan acquisitions - held for
investment 6 985 $ 164 6.9 % 64.4 %
Total loans originated and
acquired 1,812 $ 555,695
Over the periods shown, we have increased our origination volume by executing
our strategy of continuing to serve and build loyalty within our network of
mortgage brokers, while also expanding our network with new mortgage brokers
through improved brand recognition. For the year ended December 31, 2019 , we
originated $1.0 billion of loans, which was an increase of $275.4 million , or
37.4% from $737.3 million for the year ended December 31, 2018 . For the year
ended December 31, 2018 , we originated $737.3 million of loans, which was an
increase of $182.6 million , or 32.9%, from $554.7 million for the year ended
December 31, 2017 .
Loans Held for Investment
Our total portfolio of loans held for investment consists of both loans held for
investment at cost, which are presented in the consolidated financial statements
as loans held for investment, net, and loans held for investment at fair value,
which are presented in the financial statements as loans held for investment at
fair value. The following tables show the various components of loans held for
investment as of the dates indicated:
December 31,
(in thousands) 2019 2018 2017
Unpaid principal balance $ 1,843,290 $ 1,551,866 $ 1,289,739
Discount on acquired loans - (541 ) (911 )
Valuation adjustments on FVO loans (444 ) (586 ) (841 )
Deferred loan origination costs 25,714 21,812
17,572
Total loans held for investment, gross 1,868,560 1,572,551
1,305,559
Allowance for loan losses (2,240 ) (1,680 )
(1,886 )
Loans held for investment, net$ 1,866,320 $ 1,570,871 $ 1,303,673 47
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The following table illustrates the contractual maturities for our loans held
for investment in aggregate UPB and as a percentage of our total held for
investment loan portfolio as of
contractual maturities December 31, 2019
UPB %
($ in thousands)
Loans due in less than one year $ 2,170 0.1 %
Loans due in one to five years 3,023 0.2 %
Loans due in more than five years 1,838,097 99.7 %
Total loans held for investment 1,843,290 100.0 %
Allowance for Loan Losses
Our allowance for loan losses increased to $2.2 million as of December 31, 2019 ,
compared to $1.7 million as of December 31, 2018 . The increase in allowance is
primarily due to the increase in our loan portfolio from December 31, 2018 to
December 31, 2019 .
Our allowance decreased to $1.7 million as of December 31, 2018 , compared to
$1.9 million as of December 31, 2017 . The decrease in the allowance for loan
losses is based on an analysis of historical loan loss data from January 1, 2012
through December 31, 2019 . We strive to minimize actual credit losses through
our rigorous screening and underwriting process, life of loan portfolio
management and special servicing practices. Additionally, we believe borrower
equity of 25% to 40% provides significant protection against credit losses
should a loan become impaired.
To estimate the allowance for loan losses in our loans held for investment
portfolio, we follow a detailed internal process, considering a number of
different factors including, but not limited to, our ongoing analyses of loans,
historical loss rates, relevant environmental factors, relevant market research,
trends in delinquencies, effects and changes in credit concentrations, and
ongoing evaluation of fair values.
The following table illustrates the activity in our allowance for loan losses over the periods indicated:
December 31,
($ in thousands) 2019 2018 2017
Beginning balance $ 1,680 1,886 2,529
Provision for loan losses 1,139 201 421
Net charge-offs (579 ) (407 ) (1,064 )
Ending balance $ 2,240 1,680 1,886
Credit Quality - Loans Held for Investment
The following table provides delinquency information on our held for investment loan portfolio as of the dates indicated:
December 31, 2019 December 31, 2018 December 31, 2017
Current $ 1,559,373 84.6 % $ 1,358,043 87.50 % $ 1,138,749 88.3 %30-59 days past due 123,704 6.7 78,848 5.1 59,207 4.6 60-89 days past due 48,062 2.6 23,881 1.5 18,467 1.4 Nonperforming loans: 90+ days past due 24,790 1.3 16,181 1 22,114 1.7 Bankruptcy 8,695 0.5 5,901 0.4 5,631 0.5 In foreclosure 78,666 4.3 69,012 4.5 45,571 3.5 Total nonperforming loans 112,151 6.1 91,094 5.9 73,316 5.7
Total loans held for investment
100 % $ 1,289,739 100 %
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-------------------------------------------------------------------------------- Loans that are 90+ days past due, in bankruptcy, or in foreclosure are not accruing interest and are considered nonperforming loans. Nonperforming loans were$112.2 million , or 6.1% of our held for investment loan portfolio as ofDecember 31, 2019 , compared to$91.1 million , or 5.9% as ofDecember 31, 2018 , and$73.3 million , or 5.7% of the loan portfolio as ofDecember 31, 2017 . We believe the significant equity cushion at origination and the active management of loans will continue to minimize credit losses on the resolution of defaulted loans and disposition of REO properties. Historically, most loans that become nonperforming resolve prior to converting to REO. This is due to low LTVs at origination and our active management of the portfolio. The following table summarizes the cumulative number and UPB of all loans originated sinceJanuary 1, 2013 that became nonperforming at some point throughDecember 31, 2019 . We classify a loan as nonperforming when it becomes 90 days delinquent or when it enters bankruptcy or foreclosure. Of the 899 loans totaling$334.6 million in UPB that became nonperforming over the specified period, we have resolved 493 loans totaling$183.8 million in UPB, or 54.9% of the cumulative nonperforming loans. We realized a net gain of$6.0 million , or 3.3% of the resolved principal balance, on these resolutions, which is largely the result of collecting default interest and prepayment penalties in excess of the contractual interest due and collected. % of Total Resolved Gain / Gain / ($ in thousands) Loan Count UPB (1) UPB (Loss) ($) (Loss) ($)
Resolved - paid in full 347$ 137,459 74.8 %$ 7,343 5.3 % Resolved - paid current 112 32,505 17.7 511 1.6 % Resolved - REO sold 34 13,862 7.5 (1,877 ) (13.5 ) % Total resolutions 493 183,826 100 % 5,977 3.3 % Not yet resolved 406 150,811 Cumulative nonperforming loans (2) 899$ 334,637
(1) Reflects the unpaid principal balance at time of delinquency.
(2) Reflects all loans originated since 2013 that became nonperforming at some
point on or prior to
Our actual losses incurred are very small as a percentage of all loans that have ever become nonperforming. The table below shows our actual loan losses fromJanuary 1, 2013 throughDecember 31, 2019 , and through the years endedDecember 31, 2018 , 2017 and 2016. Our average annual charge-off percentage sinceJanuary 1, 2013 is approximately 0.02%. The table includes all loans originated over those periods, the year-end UPB amounts, the amount of loans that were ever nonperforming during those periods, and the actual losses for all loans that were either liquidated or converted to REO (life of loan) during the periods. January 1, January 1, January 1, January 1, 2013 to 2013 to 2013 to 2013 to December 31, December 31, December 31, December 31, ($ in thousands) 2019 2018 2017 2016 Loan originations$ 3,046,257 $ 2,373,034 $ 1,786,023 $ 1,274,509 End of period UPB 1,792,789 1,502,526 1,248,087 982,191 Nonperforming loans(1) 334,637 227,469 152,209 76,449 Cumulative charge-offs(2) 2,255 1,551 1,171 326 Average annual charge-offs(3) 322 258 234 81 Cumulative charge-off percentage(4) 0.13 % 0.10 % 0.09 % 0.03 % Average annual charge-off percentage(5) 0.02 % 0.02 % 0.02 % 0.01 %
(1) Reflects UPB of all loans originated since
nonperforming at some point during the period indicated.
(2) Reflects the total charge-offs on loans that were nonperforming and have
been liquidated or converted to REO from
indicated.
(3) Reflects the average annual charge-offs on loans that were nonperforming and
have been liquidated or converted to REO from
date indicated.
(4) Reflects the cumulative charge-offs as a percent of the end of period UPB.
(5) Reflects the average annual charge-offs as a percent of the end of period
UPB.
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Concentrations - Loans Held for Investment
As ofDecember 31, 2019 , our held for investment loan portfolio was concentrated in investor 1-4 loans, representing 46.6% of the UPB. Mixed used properties represented 13.6% of the UPB and multifamily properties represented 10.7% of the UPB. No other property type represented more than 10.0% of our held for investment loan portfolio. By geography, the principal balance of our loans held for investment were concentrated 23.7% inNew York , 22.2% inCalifornia , 12.1% inFlorida , and 8.1% inNew Jersey . Property Type December 31, 2019 % of Total ($ in thousands) Loan Count UPB UPB Investor 1-4 3,245$ 859,417 46.6 % Mixed use 666 251,339 13.6 Multifamily 475 198,018 10.7 Retail 417 179,778 9.8 Office 281 117,018 6.4 Warehouse 192 100,853 5.5 Other(1) 364 136,867 7.4 Total loans held for investment 5,640$ 1,843,290 100 %
(1) All other properties individually comprise less than 5.0% of the total
unpaid principal balance.
Geography (State) December 31, 2019
% of Total
($ in thousands) Loan Count UPB UPB
New York 938 $ 437,538 23.7 %
California 923 409,557 22.2
Florida 794 222,224 12.1
New Jersey 605 148,484 8.1
Other(1) 2,380 625,487 33.9
Total loans held for investment 5,640 $ 1,843,290 100.0 %
(1) All other states individually comprise less than 5.0% of the total unpaid
principal balance.
Loans Held for Sale
We started originating short-term, interest-only loans in March 2017 , which we
have historically aggregated and sold at a premium to par to institutional
investors. During the year ended December 31, 2019 and 2018, we originated
$338.8 million and $150.1 million of loans held for sale and sold $179.6 million
and $72.9 million of held for sale loans, respectively. Given our increased
experience providing these loans, we are currently evaluating long-term
financing alternatives for these short-term, interest-only loans, and may elect
to retain these loans in the future to be more consistent with our investment
strategy of holding loans in our portfolio and earning a longer-term spread. As
of December 31, 2019 , our portfolio of loans held for sale, which were carried
at the lower of cost or estimated fair value consisted of 733 loans with an
aggregate UPB of $216.1 million , and carried a weighted average original loan
term of 17.7 months, a weighted average coupon of 10.0%, and a weighted average
LTV at origination of 68.6%.
The following tables show the various components of loans held for sale as of
the dates indicated:
December 31,
($ in thousands) 2019 2018 2017
UPB $ 216,054 $ 79,335 $ 5,701
Valuation adjustments (396 ) (173 ) -
Deferred loan origination fees, net (1,191 ) (716 ) (50 )
Total loans held for sale, net $ 214,467 $ 78,446 $ 5,651
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Concentrations - Loans Held for Sale
As ofDecember 31, 2019 , our held for sale loan portfolio was entirely concentrated in investor 1-4 loans, representing 100.0% of the UPB. By geography, the principal balance of our loans held for sale were concentrated 25.2% inCalifornia , 11.5% inNew York , 9.1% inFlorida , 8.2% inNew Jersey , and 5.2% inMassachusetts . Geography (State) December 31, 2019 % of Total ($ in thousands) Loan Count UPB UPB California 89$ 24,549 11.4 % New York 56 55,103 25.5 Florida 87 19,668 9.1 New Jersey 75 17,479 8.1 Massachusetts 30 11,363 5.2 Texas 55 16,587 7.7 Georgia 51 12,538 5.8 Other(1) 290 58,767 27.2 Total loans held for sale 733$ 216,054 100.0 %
(1) All other states individually comprise less than 5.0% of the total UPB.
Real Estate Owned (REO)
REO includes real estate we acquire through foreclosure or by deed-in-lieu of foreclosure. REO assets are initially recorded at fair value, less estimated costs to sell, on the date of foreclosure. Adjustments that reduce the carrying value of the loan to the fair value of the real estate at the time of foreclosure are recognized as charge-offs in the allowance for loan losses. Positive adjustments at the time of foreclosure are recognized in other operating income. After foreclosure, we periodically obtain new valuations and any subsequent changes to fair value, less estimated costs to sell, are reflected as valuation adjustments. As ofDecember 31, 2019 , our REO included 24 properties with an estimated fair value of$13.1 million compared to 12 properties with an estimated fair value of$7.2 million as ofDecember 31, 2018 . Key Performance Metrics Year Ended December 31, ($ in thousands) 2019 2018 2017 Average loans$ 1,782,558 $ 1,429,877 $ 1,167,999 Portfolio yield 8.84 % 8.72 % 8.38 % Average debt - portfolio related 1,603,459 1,234,818
965,987
Average debt - total company 1,745,728 1,362,412
1,090,532
Cost of funds - portfolio related 5.23 % 5.07
% 4.93 %
Cost of funds - total company 5.64 % 5.57
% 5.62 %
Net interest margin - portfolio related 4.13 % 4.34 % 4.30 %
Net interest margin - total company 3.31 % 3.41 % 3.13 %
Charge-offs 0.03 % 0.03 % 0.09 %
Pre-tax return on equity 17.37 % 14.30 % 10.80 %
Return on equity 11.78 % 7.80 % 10.80 %
Average Loans
Average loans reflects the daily average of total outstanding loans, including
both loans held for investment and loans held for sale, as measured by UPB, over
the specified time period.
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Portfolio Yield
Portfolio yield is an annualized measure of the total interest income earned on our loan portfolio as a percentage of average loans over the given period. Interest income includes interest earned on performing loans, cash interest received on nonperforming loans, default interest and prepayment fees. The increase in our portfolio yield over the periods shown was driven by higher collections of contractual and default interest on nonperforming loans due to the efficiency and expertise of our asset management area, and, to a lesser extent, an increase in the weighted average coupon on the loans in our portfolio.
Average Debt -
Portfolio-related debt consists of borrowings related directly to financing our loan portfolio, which includes our warehouse repurchase facilities and securitizations. Total company debt consists of portfolio- related debt and corporate debt. The measures presented here reflects the monthly average of all portfolio- related and total company debt, as measured by outstanding principal balance, over the specified time period.
Cost of Funds -
Portfolio related cost of funds is an annualized measure of the interest expense incurred on our portfolio-related debt as a percentage of average portfolio-related debt outstanding over the given period. Total company cost of funds is an annualized measure of the interest expense incurred on our portfolio-related debt and corporate debt outstanding over the given period. Interest expense includes the amortization of expenses incurred in connection with our portfolio related financing activities and corporate debt. Through the issuance of long-term securitizations, we have been able to fix a significant portion of our borrowing costs over time. The strong credit performance on our securitizations has allowed us to issue debt at attractive rates. Our portfolio related cost of funds increased to 5.23% for the year endedDecember 31, 2019 from 5.07% and 4.93% for the years endedDecember 31, 2018 and 2017, respectively. The increase in portfolio related cost of funds was the result of the seasoning of older, more costly securitizations, and to a lesser extent, the increasing LIBOR index rates, partially offset by lower spreads paid to investors in our more recent securitizations. As we have continued to add more of the lower-cost securitizations, our interest cost has started to decrease, averaging 5.00% for the fourth quarter of 2019.
Net Interest Margin -
Portfolio related net interest margin measures the difference between the
interest income earned on our loan portfolio and the interest expense paid on
our portfolio-related debt as a percentage of average loans over the specified
time period. Total company net interest margin measures the difference between
the interest income earned on our loan portfolio and the interest expense paid
on our portfolio-related debt and corporate debt as a percentage of average
loans over the specified time period. Over the periods shown, our portfolio
related net interest margin decreased as a result of the seasoning of older,
more costly securitizations and, to a lesser extent, the increasing LIBOR index
rates, partially offset by higher portfolio yields and lower spreads paid to
investors in our more recent securitizations. In addition to achieving lower
spreads in our more recent securitizations, we have also been able to utilize
more favorable structures that will result in a lower and more stable cost of
funds over the life of the securities.
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The following tables show the average outstanding balance of our loan portfolio
and portfolio-related debt, together with interest income and the corresponding
yield earned on our portfolio, and interest expense and the corresponding rate
paid on our portfolio-related debt for the periods indicated:
Year Ended December 31, 2019 Year Ended December 31, 2018 Year Ended December 31, 2017
Interest Average Interest Average Interest Average
Average Income / Yield / Average Income / Yield / Average Income / Yield /
($ in thousands) Balance Expense Rate Balance Expense Rate Balance Expense
Rate Loan portfolio: Loans held for sale$ 106,852 $ 26,306 $ 3,657 Loans held for investment 1,675,706 1,403,571 1,164,342 Total loans$ 1,782,558 $ 157,531 8.84 % $
1,429,877
8.38 %
Debt:
Warehouse and
repurchase facilities
171,637$ 9,213 5.37 %$ 145,878 $ 7,185 4.93 % Securitizations 1,362,851 70,320 5.16 % 1,063,181 53,384 5.02 % 820,109 40,453 4.93 % Total debt - portfolio related 1,603,459 83,903 5.23 %
1,234,818 62,597 5.07 % 965,987 47,638
4.93 %
Corporate debt 142,269 14,617 10.27 % 127,594 13,322 10.44 % 124,545 13,654
10.96 %
Total debt $ 1,745,728 $ 98,520 5.64 % $
1,362,412
5.62 %
Net interest spread -
portfolio related (1) 3.60 % 3.65 % 3.45 % Net interest margin - portfolio related 4.13 % 4.34 % 4.30 % Net interest spread - total company (2) 3.19 % 3.15 % 2.76 % Net interest margin - total company 3.31 % 3.41 % 3.13 %
(1) Net interest spread - portfolio related is the difference between the rate
earned on our loan portfolio and the interest rates paid on our
portfolio-related debt.
(2) Net interest spread - total company is the difference between the rate
earned on our loan portfolio and the interest rates paid on our total debt.
Charge-Offs
The charge-offs ratio reflects charge-offs as a percentage of average loans held
for investment over the specified time period. We do not record charge-offs on
our loans held for sale which are carried at the lower of cost or estimated fair
value.
53
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Pre-Tax Return on Equity and Return on Equity
Pre-tax return on equity and return on equity reflect income before income taxes and net income, respectively, as a percentage of the monthly average of members' equity over the specified time period. The Company was not subject to income tax prior toJanuary 1, 2018 because prior to that time it elected to be treated as a partnership forU.S. federal income tax purposes. Year Ended December 31, ($ in thousands) 2019 2018 2017
Income before income taxes (A)
Net income (B) 17,292 7,631 13,989
Monthly average balance:
Members' equity (C) 146,236 134,913 128,940
Pre-tax return on equity (A / C) 17.4 % 14.3 % 10.8 %
Return on equity (B / C) 11.8 % 5.7 % 10.8 %
Components of Results of Operations
Interest Income
We accrue interest on the UPB of our loans in accordance with the individual terms and conditions of each loan, discontinuing interest and reversing previously accrued interest once a loan becomes 90 days or more past due (nonaccrual status). When a loan is placed on nonaccrual status, the accrued and unpaid interest is reversed as a reduction to interest income and accrued interest receivable. Interest income is subsequently recognized only to the extent that cash payments are received or when the loan has returned to accrual status. Payments received on nonaccrual loans are first applied to interest due, then principal. Interest accrual resumes once a borrower has made all principal and interest payments due, bringing the loan back to current status. Interest income on loans held for investment is comprised of interest income on loans and prepayment fees less the amortization of deferred net costs related to the origination of loans. Interest income on loans held for sale is comprised of interest income earned on loans prior to their sale. The net fees and costs associated with loans held for sale are deferred as part of the carrying value of the loan and recognized as a gain or loss on the sale of the loan.
Interest Expense - Portfolio Related
Portfolio related interest expense is incurred on the debt we incur to fund our loan origination and portfolio activities and consists of our warehouse repurchase facilities and securitizations. Portfolio related interest expense also includes the amortization of expenses incurred as a result of issuing the debt, which are amortized using the level yield method. Key drivers of interest expense include the debt amounts outstanding, interest rates, and the mix of our securitizations and warehouse liabilities.
Net Interest Income - Portfolio Related
Portfolio related net interest income represents the difference between interest income and portfolio related interest expense.
Interest Expense - Corporate Debt
ThroughDecember 31, 2019 , interest expense on corporate debt primarily consists of interest expense paid with respect to the 2014 Senior Secured Notes and the 2019 Term Loans, as reflected on our consolidated statement of financial condition, and the related amortization of deferred debt issuance costs. 54 -------------------------------------------------------------------------------- InAugust 2019 , we redeemed the 2014 Senior Secured Notes and repurchased our outstanding Class C preferred units with the proceeds of the 2019 Term Loans, which bear interest at a rate equal to the one-month LIBOR plus 7.50% and mature inAugust 2024 , together with cash on hand. We used$75.7 million of the net proceeds from our IPO to repay$75.0 million in outstanding principal amount on the 2019 Term Loans. Net Interest Income
Net interest income represents the difference between portfolio related net interest income and interest expense on corporate debt.
Provision for Loan Losses
Provision for loan losses consists of amounts charged to income during the period to maintain an estimated allowance for loan and lease losses, or ALLL, to provide for probable credit losses inherent in our existing portfolio of loans held for investment (excluding those loans which we have elected to carry at fair value). The ALLL consists of a specific valuation allowance on those loans that are 90 days or more delinquent, in bankruptcy, or in foreclosure, and a general reserve allowance for all other loans in our existing portfolio.
Other Operating Income
Gain on Disposition of Loans. When we sell a loan held for sale, we record a gain or loss that reflects the difference between the proceeds received for the sale of the loans and their respective carrying values. The gain or loss that we ultimately realize on the sale of our loans held for sale is primarily determined by the terms of the originated loans, current market interest rates and the sales price of the loans. In addition, when we transfer a loan to REO, we record the REO at its fair value at the time of the transfer. The difference between the fair value of the real estate and the carrying value of the loan is recorded as a gain or loss. Lastly, when our acquired loans, which were purchased at a discount, pay off, we record a gain related the write-off of the remaining purchase discount. Unrealized Gain/(Loss) on Fair Value Loans. We have elected to account for certain purchased distressed loans at fair value using FASB ASC Topic 825, Financial Instruments (ASC 825). We regularly estimate the fair value of these loans as discussed more fully in the notes to our consolidated financial statements included elsewhere in this prospectus. Changes in fair value are reported as a component of other operating income within our consolidated statements of operations.
Other Income. Other income includes the following:
Unrealized Gains/(Losses) onRetained Interest Only Securities . As part of the proceeds received for the sale of our held for sale loans, we may receive an interest only security that we mark to fair value at the end of each period.
Fee Income. In certain situations, we collect fee income by originating loans and realizing miscellaneous fees such as late fees.
Operating Expenses
Compensation and Employee Benefits. Costs related to employee compensation, commissions and related employee benefits, such as health, retirement, and payroll taxes.
Rent and Occupancy. Costs related to occupying our locations, including rent, maintenance and property taxes.
Loan Servicing. Costs related to our third-party servicers.
Professional Fees. Costs related to professional services, such as external audits, legal fees, tax, compliance and outside consultants.
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Real Estate Owned, Net. Costs related to our real estate owned, net, including
gains/(losses) on disposition of REO, maintenance of REO properties, and taxes
and insurance.
Other Operating Expenses. Other operating expenses consist of general and administrative costs such as, travel and entertainment, marketing, data processing, insurance and office equipment.
Provision for Income Taxes
The provision for income taxes consists of the current and deferredU.S. federal and state income taxes we expect to pay, currently and in future years, with respect to the net income for the year. The amount of the provision is derived by adjusting our reported net income with various permanent differences. The tax- adjusted net income amount is then multiplied by the applicable federal and state income tax rates to arrive at the provision for income taxes. Prior toJanuary 1, 2018 , we had elected to be treated as a partnership forU.S. federal income tax purposes and were, therefore, not required to pay income taxes because of our treatment as a pass-through entity. EffectiveJanuary 1, 2018 , we changed our election to be taxed as a corporation forU.S. federal income tax purposes and are now recording provisions for income taxes. Consolidated Results of Operations
The following table summarizes our consolidated results of operations for the periods indicated:
Summary Consolidated Results of Operations Year Ended December 31, ($ in thousands) 2019 2018 2017 Interest income$ 157,531 $ 124,722 $ 97,830 Interest expense - portfolio related 83,903 62,597 47,638 Net interest income - portfolio related 73,628 62,125 50,192 Interest expense - corporate debt 14,618 13,322 13,654 Net interest income 59,010 48,803 36,538 Provision for loan losses 1,139 201 421 Net interest income after provision for loan losses 57,871 48,602 36,117 Other operating income 2,649 2,807 2,008 Total operating expenses 35,122 32,160 24,136 Income before income taxes 25,398 19,249 13,989 Income tax expense 8,106 11,618 - Net income$ 17,292 $ 7,631 $ 13,989
Year Ended
Our earnings increase is mainly attributable to significant growth in our loan originations of 37.4% and the corresponding income earned from a higher balance of loans under management. Net interest income increased 20.9% partially offset by an increase in operating costs of 9.2%. Our net income increased 126.6% from$7.6 million for the year endedDecember 31, 2018 to$17.3 million for the year endedDecember 31, 2019 .
Net Interest Income - Portfolio Related
Year Ended December 31,
($ in thousands) 2019 2018 $ Change %Change
Interest income $ 157,531 $ 124,722 $ 32,809 26.3 %
Interest expense - portfolio related 83,903 62,597 21,306 34.0 %
Net interest income - portfolio related 73,628 62,125
18.5 %
56
-------------------------------------------------------------------------------- Interest Income. Interest income increased by$32.8 million , or 26.3%, to$157.5 million during the year endedDecember 31, 2019 , compared to$124.7 million during the year endedDecember 31, 2018 . The increase is primarily attributable to an increase in average loans (volume), which increased$352.7 million , or 24.7%, from$1.4 billion for the year endedDecember 31, 2018 to$1.8 billion for the year endedDecember 31, 2019 . The average yield (rate) over those same periods increased from 8.72% to 8.84%. The following table distinguishes between the change in interest income attributable to change in volume and the change in interest income attributable to change in rate. The effect of changes in volume is determined by multiplying the change in volume (i.e.,$352.7 million ) by the previous period's average rate (i.e., 8.72%). Similarly, the effect of rate changes is calculated by multiplying the change in average rate (i.e., 0.12%) by the current period's volume (i.e.,$1.8 billion ). Average Interest Average ($ in thousands) Loans Income Yield Year ended December 31, 2019$ 1,782,558 $ 157,531 8.84 % Year ended December 31, 2018 1,429,877 124,722 8.72 Volume variance 352,681 30,763 Rate variance 2,046 0.12 Total interest income variance$ 32,809 Interest Expense - Portfolio Related. Interest expense related to our warehouse repurchase facilities increased$4.4 million to approximately$13.6 million during the year endedDecember 31, 2019 , compared to approximately$9.2 million during the year endedDecember 31, 2018 . Interest expense related to our securitizations increased by$16.9 million to approximately$70.3 million during the year endedDecember 31, 2019 , compared to approximately$53.4 million during the year endedDecember 31, 2018 . Our cost of funds increased to 5.23% during the year endedDecember 31, 2019 from 5.07% during the year endedDecember 31, 2018 . The increase in interest expense - portfolio related was primarily due to the increase in borrowings for loan originations, as well as the impact of increased seasoning of older securitizations. As we have continued to add more of the lower-cost securitizations, our interest cost has started to decrease, averaging 5.00% for the fourth quarter of 2019. The following table presents information regarding the increase in portfolio related interest expense and distinguishes between the dollar amount of change in interest expense attributable to changes in the average outstanding debt balance (volume) versus changes in cost of funds (rate). ($ in thousands) Average Interest Cost of Debt (1) Expense Funds Year ended December 31, 2019$ 1,603,459 $ 83,903 5.23 % Year ended December 31, 2018 1,234,818 62,597 5.07 Volume variance 368,641 18,688 Rate variance 2,618 0.16 Total interest expense variance$ 21,306
(1)Includes securitizations and warehouse repurchase agreements.
Net Interest Income After Provision for Loan Losses
Year Ended December 31,
($ in thousands) 2019 2018
$ Change % Change
Net interest income - portfolio related
18.5 %
Interest expense - corporate debt 14,618 13,322 1,296 9.7 %
Net interest income 59,010 48,803 10,207 20.9 %
Provision for loan losses 1,139 201 938 466.7 %
Net interest income after provision for
loan losses $ 57,871 $ 48,602 $ 9,269 19.1 %
57
-------------------------------------------------------------------------------- Interest Expense - Corporate Debt. Corporate debt interest expense increased by$1.3 million from$13.3 million for the year endedDecember 31, 2018 to$14.6 million for the year endedDecember 31, 2019 primarily due to the increase in the corporate debt balance. InAugust 2019 , we refinanced the 2014 Senior Secured Notes with a portion of the net proceeds from the 2019 Term Loans - a five-year$153.0 million corporate debt agreement with a new lender. The corporate debt balance was$153.0 million as ofDecember 31, 2019 compared to$127.6 million as ofDecember 31, 2018 . Provision for Loan Losses. Our provision for loan losses increased by$0.9 million from$0.2 million during the year endedDecember 31, 2018 to$1.1 million during the year endedDecember 31, 2019 primarily due to the increase in the loan portfolio. Other Operating Income The table below presents the various components of other operating income for the year endedDecember 31, 2019 compared to the year endedDecember 31, 2018 . The$0.2 million net decrease is primarily due to the increase in gain on disposition of loans, offset by the valuation adjustments on interest-only strips included within other (expense) income. Year Ended December 31, ($ in thousands) 2019 2018 $ Change % Change Gain on disposition of loans$ 4,410 $ 1,201 $ 3,209 267.2 % Unrealized gain on fair value loans (9 ) 241 (250 ) (103.7 ) Other (expense) income (1,752 ) 1,365 (3,117 ) (228.4 ) Total other operating income$ 2,649 $ 2,807 $ (158 ) (5.6 ) % Operating Expenses Total operating expenses increased by$3.0 million , or 9.2%, to$35.1 million during the year endedDecember 31, 2019 from$32.2 million during the year endedDecember 31, 2018 . This increase is primarily the result of loan servicing costs associated with higher loan origination volumes and the increase in REO expense. Year Ended December 31, ($ in thousands) 2019 2018 $ Change % Change Compensation and employee benefits$ 15,511 $ 15,105 $ 406 2.7 % Rent and occupancy 1,531 1,320 211 16.0 % Loan servicing 7,396 6,009 1,387 23.1 % Professional fees 2,056 3,040 (984 ) (32.4 ) Real estate owned, net 2,647 1,373 1,274 92.8 % Other operating expenses 5,981 5,313 668 12.6 % Total operating expenses$ 35,122 $ 32,160 $ 2,962 9.2 % Compensation and Employee Benefits. Compensation and employee benefits increased from$15.1 million during the year endedDecember 31, 2018 to$15.5 million during year endedDecember 31, 2019 , mainly due to higher commission expenses and increased operations and sales staff to support our growth in loan origination volume. Rent and Occupancy. Rent and occupancy expenses increased from$1.3 million during the year endedDecember 31, 2018 to$1.5 million during the year endedDecember 31, 2019 , due to the increase in office space. Loan Servicing. Loan servicing expenses increased from$6.0 million during the year endedDecember 31, 2018 to$7.4 million during the year endedDecember 31, 2019 . The$1.4 million increase during the year endedDecember 31, 2019 is mainly due to the increase in our loan portfolio. 58 -------------------------------------------------------------------------------- Professional Fees. Professional fees decreased from$3.0 million for the year endedDecember 31, 2018 to$2.1 million for the year endedDecember 31, 2019 , mainly due to the timing of legal and external audit services rendered related to our public offering initiative. Net Expenses of Real Estate Owned. Net expenses of real estate owned increased from$1.3 million during the year endedDecember 31, 2018 to$2.6 million during the year endedDecember 31, 2019 , mainly due to the increase in valuation adjustment expense during the year endedDecember 31, 2019 . Other Operating Expenses. Other operating expenses increased from$5.3 million for the year endedDecember 31, 2018 to$6.0 million for the year endedDecember 31, 2019 , mainly due to increased data processing costs related to technology investments. Income Tax Expense. Income tax expense was$8.1 million for the year endedDecember 31, 2019 , compared to$11.6 million for the year endedDecember 31, 2018 . Our consolidated effective tax rate as a percentage of pre-tax income for 2019 was 31.9%, compared to 60.4% for 2018. The 2019 effective tax rate differed from the federal statutory rate of 21.0% principally because of state taxes.
Year Ended
Our income before income taxes increased 37.6% from$14.0 million for the year endedDecember 31, 2017 to$19.2 million for the year endedDecember 31, 2018 . Our strong earnings growth is mainly attributable to significant growth in our loan originations and a slight increase in our net interest margin. Net interest margin expansion was attributable to an increase in portfolio yield, partially offset by increasing portfolio related cost of funds.
Net Interest Income - Portfolio Related
Year Ended
December 31,
($ in thousands) 2018 2017 $ Change % Change
Interest income $ 124,722 $ 97,830 $ 26,892 27.5 %Interest expense - portfolio related 62,597 47,638 14,959
31.4 %
Net interest income - portfolio related
23.8 %
Interest Income. Interest income increased by $26.9 million , or 27.5%, to
$124.7 million during the year ended December 31, 2018 , compared to $97.8
million during the year ended December 31, 2017 . The increase is attributable to
a combination of an increase in average loans (volume) and an increase in
average yield (rate). Average loans increased $261.9 million , or 22.4%, from
$1.2 billion during the year ended December 31, 2017 to $1.4 billion during the
year ended December 31, 2018 . The average yield over those same periods
increased from 8.38% to 8.72%.
The following table distinguishes between the change in interest income
attributable to change in volume and the change in interest income attributable
to change in rate. The effect of changes in volume is determined by multiplying
the change in volume (i.e., $261.9 million ) by the previous period's average
rate (i.e., 8.38%). Similarly, the effect of rate changes is calculated by
multiplying the change in average rate (i.e., 0.34%) by the current period's
volume (i.e., $1.4 billion ).
Average Interest Average
($ in thousands) Loans Income Yield
Year ended December 31, 2018 $ 1,429,877 $ 124,722 8.72 %
Year ended December 31, 2017 1,167,999 97,830 8.38
Volume variance $ 261,878 $ 21,929
Rate variance 4,963 0.34 %
Total interest income variance $ 26,892
59
-------------------------------------------------------------------------------- Interest Expense - Portfolio Related. Interest expense related to our warehouse repurchase facilities increased$2.0 million , or 28.2%, to approximately$9.2 million during the year endedDecember 31, 2018 , compared to approximately$7.2 million during the year endedDecember 31, 2017 . Interest expense related to our securitizations increased by$12.9 million to approximately$53.4 million during the year endedDecember 31, 2018 , compared to approximately$40.5 million during the year endedDecember 31, 2017 . The increase in interest expense - portfolio related was primarily due to the increase in borrowings for loan originations. Our average cost of funds increased slightly to 5.07% during the year endedDecember 31, 2018 from 4.93% during the year endedDecember 31, 2017 . The following table presents information regarding the increase in portfolio related interest expense and distinguishes between the dollar amount of change in interest expense attributable to changes in the average outstanding debt balance (volume) versus changes in cost of funds (rate). Average Interest Cost of ($ in thousands) Debt(1) Expense Funds
Year ended
5.07 %
Year ended
4.93
Volume variance $ 268,831 $ 13,257
Rate variance 1,702 0.14 %
Total interest expense variance $ 14,959 (1) Includes securitizations and warehouse repurchase agreements.
Net Interest Income After Provision for Loan Losses
Year Ended December 31,
($ in thousands) 2018 2017 $ Change % Change
Net interest income - portfolio related $ 62,125 $ 50,192 $ 11,933 23.8 %
Interest expense - corporate debt 13,322 13,654 (332 ) (2.4 )
Net interest income 48,803 36,538 12,265 33.6
Provision for loan losses 201 421 (220 ) (52.3 )
Net interest income after provision for
loan losses $ 48,602 $ 36,117 $ 12,485 34.6 %
Interest Expense - Corporate Debt. Under the 2014 Senior Secured Notes,
interest paid-in-kind accrues at an 11.0% interest rate and interest paid in
cash accrues at a 10.0% interest rate. During the first half of 2017, the
interest due on the 2014 Senior Secured Notes was paid-in-kind. During the
second half of 2017, and during the year ended 2018, the interest due was paid
in cash. The change in interest payments resulted in a 2.4% decrease in
corporate debt interest expense from $13.7 million during the year ended
December 31, 2017 to $13.3 million during the year ended December 31, 2018 . We
used $75.7 million of the net proceeds from our IPO to reduce interest expense
through the repayment of $75.0 million in outstanding principal amount on the
2019 Term Loans, which refinanced the 2014 Senior Secured Notes in August 2019 .
Provision for Loan Losses. Our provision for loan losses decreased
60
--------------------------------------------------------------------------------Other Operating Income
The table below presents the various components of other operating income for the year endedDecember 31, 2018 compared to the year endedDecember 31, 2017 . The$0.8 million increase is primarily the result of the increased gain on sale of loans. Year Ended December 31, ($ in thousands) 2018 2017 $ Change % Change Gain on disposition of loans$ 1,200 $ 984 $ 216 22.0 % Unrealized gain on fair value loans 241 39 202 - Other income 1,366 985 381 38.7 % Total other operating income$ 2,807 $ 2,008 $ 799 39.8 % Operating Expenses Total operating expenses increased$8.0 million , or 33.2%, to$32.2 million during the year endedDecember 31, 2018 from$24.1 million during the year endedDecember 31, 2017 . This increase is primarily the result of additional personnel and loan servicing costs associated with higher loan origination volumes. Year Ended December 31, ($ in thousands) 2018 2017 $ Change % Change Compensation and employee benefits$ 15,105 $ 11,904 $ 3,201 26.9 % Rent and occupancy 1,320 1,115 205 18.4 % Loan servicing 6,009 4,907 1,102 22.5 % Professional fees 3,040 1,661 1,379 83.0 % Real estate owned, net 1,373 603 770 127.7 % Other operating expenses 5,313 3,946 1,367 34.6 % Total operating expenses$ 32,160 $ 24,136 $ 8,024 33.2 % Compensation and Employee Benefits. Compensation and employee benefits increased from$11.9 million during the year endedDecember 31, 2017 to$15.1 million during the year endedDecember 31, 2018 mainly due to higher commission expenses and increased operations and sales staff to support our growth in loan origination volume. Rent and Occupancy. Rent and occupancy expenses increased from$1.1 million during the year endedDecember 31, 2017 to$1.3 million during the year endedDecember 31, 2018 due to the opening of two new sales offices. Loan Servicing. Loan servicing expenses increased from$4.9 million during the year endedDecember 31, 2017 to$6.0 million during the year endedDecember 31, 2018 . The$1.1 million increase during 2018 is primarily related to the increase in our loan portfolio. Professional Fees. Professional fees increased from$1.7 million for the year endedDecember 31, 2017 to$3.0 million for the year endedDecember 31, 2018 mainly due to increased legal and external audit fees related to our public offering initiative. Net Expenses of Real Estate Owned. Net expenses of real estate owned increased from$0.6 million during the year endedDecember 31, 2017 to$1.4 million during the year endedDecember 31, 2018 , mainly as a result of a$0.7 million increase in REO valuation adjustments. Other Operating Expenses. Other operating expenses increased from$3.9 million for the year endedDecember 31, 2017 to$5.3 million for the year endedDecember 31, 2018 mainly due to increased data processing costs related to technology investments. 61
-------------------------------------------------------------------------------- Income Tax Expense. Income tax expense was$11.6 million , and our consolidated effective tax rate was 60.4% for the year endedDecember 31, 2018 . The Company elected to be treated as a corporation forU.S. federal and state income tax purposes effectiveJanuary 1, 2018 . Prior toJanuary 1, 2018 , the Company was a limited liability company and it was not subject toU.S. federal and state income tax. Liquidity and Capital Resources
Sources and Uses of Liquidity
We fund our lending activities primarily through borrowings under our warehouse repurchase facilities, securitizations, members' equity and other corporate-level debt, equity and debt securities, and net cash provided by operating activities to manage our business. We use cash to originate and acquire investor real estate loans, repay principal and interest on our borrowings, fund our operations and meet other general business needs.
As a result of the spread of the COVID-19, economic uncertainties have arisen which are likely to negatively impact our financial condition, results of operations and cash flows. We have recently executed a number of business initiatives to strengthen our liquidity and capital resources position in light of the impact of COVID-19. As part of these initiatives, onApril 6, 2020 , we entered into amendments to our warehouse repurchase agreements and issued and sold$45.0 million in gross proceeds of Preferred Stock and Warrants. See below under "-Warehouse Repurchase Facilities" and "-April 2020 Preferred Stock and Warrants." Cash and Cash Equivalents As ofDecember 31, 2019 , we had liquidity of approximately$26.4 million in cash and eligible collateral borrowings under our warehouse facilities. Cash comprised$21.5 million of our liquidity and eligible collateral borrowings under our warehouse facilities comprised$4.9 million of our liquidity. As ofDecember 31, 2019 , we had$80.3 million of uncommitted available capacity under our warehouse facilities. As ofDecember 31, 2018 , we had liquidity of approximately$60.0 million in cash and eligible collateral borrowings under our warehouse facilities. Cash comprised$15.0 million of our liquidity and eligible collateral borrowings under our warehouse facilities comprised$45.0 million of our liquidity. As ofDecember 31, 2018 , we had$283.3 million of uncommitted available capacity under our warehouse facilities.
During the year ended
Warehouse Repurchase Facilities
As ofDecember 31, 2019 , we had two warehouse repurchase agreements to support our loan origination and acquisition activities. Both agreements are short-term borrowing facilities. The borrowings are collateralized by pools of primarily performing loans, bearing interest at one-month LIBOR plus a margin that ranges from 2.75% to 3.00%. As ofDecember 31, 2019 , these two agreements had an aggregated maximum borrowing capacity of$450.0 million , of which$200.0 million were committed amounts and$250.0 million were uncommitted amounts. The maximum capacity increased from$450.0 million to$500.0 million effectiveMarch 11, 2020 . Borrowings under these repurchase facilities as ofDecember 31, 2019 were$417.2 million . As ofDecember 31, 2018 , we had two warehouse repurchase agreements to support our loan origination and acquisition activities. Both agreements are short-term borrowing facilities. The borrowings are collateralized by pools of primarily performing loans, bearing interest at one-month LIBOR plus a margin that ranges from 2.75% to 3.00%. As ofDecember 31, 2018 , these two agreements had an aggregated maximum borrowing capacity of$450.0 million , of which$200.0 million were committed amounts and$250.0 million were uncommitted amounts. Borrowings under these repurchase facilities as ofDecember 31, 2018 were$216.4 million . 62 -------------------------------------------------------------------------------- In addition to the two warehouse repurchase agreements, we also have a longer term warehouse agreement, which was added inSeptember 2018 . The borrowings are collateralized by pools of primarily performing loans, with a maximum borrowing capacity of$50 million , bearing interest at one-month LIBOR plus a margin of 3.50%. The warehouse repurchase facility has a maturity date ofSeptember 12, 2021 and allows loans to be financed for a period of up to three years. Borrowings under this warehouse agreement as ofDecember 31, 2019 were$2.5 million . All warehouse repurchase facilities fund less than 100% of the principal balance of the mortgage loans we own requiring us to use working capital to fund the remaining portion. We may need to use additional working capital if loans become delinquent, because the amount permitted to be financed by the facilities may change based on the delinquency performance of the pledged collateral. All borrower payments on loans financed under the warehouse agreements are segregated into pledged accounts with the loan servicer. All principal amounts in excess of the interest due are applied to reduce the outstanding borrowings under the warehouse repurchase facilities, which then allows us to draw additional funds on a revolving basis under the facilities. The revolving warehouse repurchase facilities also contain customary covenants, including financial covenants that require us to maintain a minimum net worth, a maximum debt-to- net worth ratio and a ratio of a minimum earnings before interest, taxes, depreciation and amortization to interest expense. If we fail to meet any of the covenants or otherwise default under the facilities, the lenders have the right to terminate their facility and require immediate repayment, which may require us to sell our loans at less than optimal terms. As ofDecember 31, 2019 , we were in compliance with these covenants. In response to the dislocations in the markets related to the COVID-19 pandemic and its unknown future impact on the value of our financed collateral, onApril 6, 2020 , we entered into amendments to the master repurchase agreements on both of our warehouse repurchase agreements with the lenders under such agreements. We believe that the amended warehouse repurchase agreements provide us with a flexible and more stabilized financing solution that will allow us to better operate our business under the current market conditions. Pursuant to the terms of the warehouse repurchase amendments, (i) we must maintain unrestricted cash and cash equivalents of at least$7.5 million , (ii) we were required to make aggregate payments of$20.0 million to reduce our obligations under the warehouse repurchase agreements onApril 6, 2020 , and (iii) we must ensure that payments of at least$3.0 million per month are made to each lender, from the cash flow of the underlying financed loans and/or corporate cash each month fromApril 6 through August 3, 2020 , in reduction of its obligations thereunder. In addition, the interest rate under each warehouse repurchase facility was increased by 25 basis points, effective as ofApril 6, 2020 .
Securitizations
FromMay 2011 throughOctober 2019 , we have completed twelve securitizations of$2.7 billion of investor real estate loans, issuing$2.5 billion in principal amount of securities to third parties through twelve respective transactions. InFebruary 2020 , we completed our thirteenth securitization issuing$248.7million in principal amount of securities for$261.9 million of mortgage loans. All borrower payments are segregated into remittance accounts at the primary servicer and remitted to the trustee of each trust monthly. We are the sole beneficial interest holder of the applicable trusts, which are variable interest entities included in our consolidated financial statements. The transactions are accounted for as a secured borrowings underU.S. GAAP. Table summarizing the investor real estate loans securitized, securities issued, securities retained by the Company at the time of the securitization, and as ofDecember 31, 2019 and 2018, the stated maturity for each securitization, the outstanding bond balances, and the weighted average on the securities for the Trusts as ofDecember 31, 2019 and 2018, are included in Item 15. Exhibits, Financial Statement Schedules. The securities are callable by us when the stated principal balance is less than a certain percentage, ranging from 5%-30%, of the original stated principal balance of loans at issuance. As a result, the actual maturity date of the securities issued will likely be earlier than their respective stated maturity date. Our intent is to use the proceeds from the issuance of new securities primarily to repay our warehouse borrowings and originate new investor real estate loans in accordance with our underwriting guidelines, as well as for general corporate purposes. Our financing sources may include borrowings in the form of additional bank credit facilities (including term loans and revolving credit facilities), repurchase agreements, warehouse repurchase facilities and other sources of private financing. We also plan to continue using securitization as long-term financing for our portfolio, and we do not plan to structure any securitizations as sales or utilize off-balance-sheet vehicles. 63 --------------------------------------------------------------------------------
We believe any financing of assets and/or securitizations we may undertake will be sufficient to fund our working capital requirements.
Cash Flows
The following table summarizes the net cash provided by (used in) operating
activities, investing activities and financing activities as of the periods
indicated:
Year Ended December 31,
($ in thousands) 2019 2018 2017Cash provided by (used in):
Operating activities$ (105,336 ) $ (72,485 ) $ 37,644 Investing activities (305,934 ) (270,196 ) (274,779 ) Financing activities 422,145 343,631 201,118
Net change in cash, cash equivalents, and
$ (36,017 ) restricted cash Operating Activities
Cash flows from operating activities primarily includes net income adjusted for (1) cash used for origination of held for sale loans and the related cash proceeds from the sales of such loans, (2) non-cash items including depreciation, provision for loan loss, discount accretion, and valuation changes, and (3) changes in the balances of operating assets and liabilities.
For the year endedDecember 31, 2019 , our net cash used in operating activities of$105.3 million consisted mainly of$336.9 million cash used to originate held for sale loans, offset by$179.6 million proceeds from sale of loans held for sale,$25.1 million in repayments on loans held for sale, and net income of$17.3 million . For the year endedDecember 31, 2018 , our net cash used in operating activities of$72.5 million consisted mainly of net income of$7.6 million , offset by$148.8 million in cash used to originate held for sale loans, less proceeds from the sale and repayments of loans held for sale of$72.9 million and$3.5 million , respectively. Changes in operating assets and liabilities resulted in cash used of$18.9 million , mainly as a result of a$16.2 million increase in interest receivable due to portfolio growth. For the year endedDecember 31, 2017 , our net cash provided by operating activities of$37.6 million consisted mainly of net income of$14.0 million , offset by$42.9 million in cash used to originate held for sale loans, less proceeds from the sale of such loans of$46.3 million . Changes in operating assets and liabilities resulted in cash provided of$4.8 million . Interest paid in kind on our corporate debt resulted in a positive non-cash adjustment to net income of$6.7 million . Investing Activities For the year endedDecember 31, 2019 , our net cash used in investing activities of$305.9 million consisted mainly of$682.9 million in cash used to originate held for investment loans, offset by$379.3 million in cash received in payments on held for investment loans. We also used cash to purchase$9.3 million of loans for investment. We also received cash of$4.5 million from proceeds of the sale of REO. For the year endedDecember 31, 2018 , our net cash used in investing activities of$270.2 million consisted mainly of$595.7 million in cash used to originate held for investment loans, less$334.7 million in cash received in payments on held for investment loans. We also received cash of$6.2 million from proceeds of the sale of REO. For the year endedDecember 31, 2017 , our net cash used in investing activities of$274.8 million consisted mainly of$518.9 million in cash used to originate held for investment loans, less$240.9 million in cash received in payments on held for investment loans. We also received cash of$6.3 million from proceeds of the sale of loans and$2.5 million from proceeds on the sale of REO. 64 --------------------------------------------------------------------------------
Financing Activities
For the year endedDecember 31, 2019 , our net cash provided by financing activities of$422.1 million consisted mainly of$961.7 million and$608.1 million in cash from borrowings from our warehouse repurchase facilities and securitizations issued, respectively. This cash generated was partially offset by payments we made of$756.0 million and$371.4 million on our warehouse repurchase facilities and securitizations issued, respectively. The 2019 Term Loans generated$153.0 million of cash, of which$127.6 million was used to redeem the 2014 Secured Notes, and$27.7 million was used to repurchase the Class C preferred units as return of capital. We used cash of$17.9 million for debt issuance costs. For the year endedDecember 31, 2018 , our net cash provided by financing activities of$343.6 million consisted mainly of$658.5 million and$535.5 million in cash from borrowings from our warehouse repurchase facilities and securitizations issued, respectively. This cash generated was partially offset by payments we made of$527.9 million and$314.7 million on our warehouse repurchase facilities and securitizations issued, respectively. We used cash of$7.8 million for debt issuance costs. For the year endedDecember 31, 2017 , our net cash provided by financing activities of$201.1 million consisted mainly of$420.5 million and$455.3 million in cash from borrowings from our warehouse repurchase facilities and securitizations issued, respectively. This cash generated was partially offset by payments we made of$445.7 million and$214.4 million on our warehouse repurchase facilities and securitizations issued, respectively. We used cash of$7.8 million for debt issuance costs and$6.9 million for tax distributions.
OnApril 5, 2020 , we sold 45,000 shares of Preferred Stock and Warrants to purchase 3,013,125 shares of our common stock in a private placement to two of our largest stockholders. These offerings resulted in aggregate gross proceeds of$45.0 million , before expenses payable by us of approximately$1.0 million . The proceeds will be used for general corporate purposes and to strengthen our liquidity position during this current economic crisis. Beginning onOctober 5, 2022 , but in no event later thanNovember 28, 2024 , each holder of Preferred Stock has the option to cause us to repurchase all or a portion of such holder's shares of Preferred Stock, for an amount in cash equal to the liquidation preference of each share repurchased. The Preferred Stock has a liquidation preference equal to the greater of (i)$2,000 per share fromApril 5, 2020 throughOctober 5, 2022 , which amount increases ratably to$3,000 per share betweenOctober 6, 2022 andNovember 28, 2024 and to$3,000 per share from and afterNovember 28, 2024 and (ii) the amount such Preferred Stock holder would have received if the Preferred Stock had converted into common stock immediately prior to such liquidation. We also have an obligation to repurchase the Preferred Stock for cash at a price per share equal to the liquidation preference in the event of a change of control (as defined in the certificate of designation governing the Preferred Stock). The Warrants are exercisable at the warrantholder's option at any time and from time to time, in whole or in part, untilApril 5, 2025 at an exercise price of$2.96 per share of common stock with respect to 2,008,750 of the Warrants, and at an exercise price of$4.94 per share of common stock with respect to 1,004,374 of the Warrants. For more information about the Preferred Stock and the Warrants, see "Note 24 - Subsequent Events" in the footnotes to the consolidated financial statements included in this Annual Report. Contractual Obligations and Commitments In 2014, we entered into a five-year,$100.0 million corporate debt agreement with the owners of the Class C preferred units, pursuant to which we issued at par senior secured notes that mature onDecember 16, 2019 , the 2014 Senior Secured Notes. The 2014 Senior Secured Notes bear interest at either 10% annually paid in cash or 11% annually paid-in-kind onJune 15 andDecember 15 of each year. All principal and paid-in-kind interests are due at maturity. InAugust 2019 , we entered into a five-year$153.0 million corporate debt agreement with Owl Rock Capital Corporation. The 2019 Term Loans under this agreement bear interest a rate equal to one-month LIBOR plus 7.50% and mature inAugust 2024 . A portion of the net proceeds from the 2019 Term Loans was used to redeem the 2014 Senior Secured Notes. As ofDecember 31, 2019 , 2018, and 2017, including paid-in-kind interest, the aggregate outstanding principal amount of the 2014 Senior Secured Notes was zero,$127.6 million and$127.6 65 -------------------------------------------------------------------------------- million, respectively. As ofDecember 31, 2019 , the outstanding principal amount of the 2019 Term Notes was$153.0 million . Another portion of the net proceeds from the 2019 Term Loans, together with cash on hand, was used to repurchase our outstanding Class C preferred units. The 2019 Term Loans mature inAugust 2024 and are subject to a 0.25% quarterly amortization beginning on the fifth full fiscal quarter afterAugust 2019 .Velocity Commercial Capital, LLC is the borrower of the 2019 Term Loans, which are secured by substantially all of the borrower's non-warehoused assets, with a guarantee fromVelocity Financial, Inc. , formerlyVelocity Financial LLC , that is secured by the equity interests of the borrower. The corporate debt agreement contains customary affirmative and negative covenants, including financial maintenance covenants and limitations on dividends by the borrower. As ofDecember 31, 2019 , we maintained warehouse and repurchase facilities to finance our investor real estate loans and had approximately$417.2 million in outstanding borrowings with$80.3 million of available capacity under our warehouse and repurchase facilities. The following table illustrates our contractual obligations existing as ofDecember 31, 2019 : January 1, 2020 - January 1, 2021 - January 1, 2023 - ($ in thousands) December 31, 2020 December 31, 2022 December 31, 2024 Thereafter Total Warehouse repurchase $ 417,188 $ 5,499 $ - $ -$ 422,687 facilities (1) Notes payable (corporate 382 3,060 149,558 - 153,000 debt) (2) Leases payments under noncancelable operating 1,526 3,184 2,460 55 7,225 leases Total $ 419,096 $ 11,743 $ 152,018 $ 55$ 582,912 (1) Amount represents gross warehouse and repurchase borrowing. Balance of$421.5 million in the consolidated statement of financial condition as of
2019, the Citibank Repurchase Agreement was amended to be due in August
2020. In
due in
further amended to be due
(2) In
agreement and a portion of the proceeds of the 2019 Term Loans under this
agreement were used to redeem the then outstanding corporate debt. The 2019
Term Loans mature in
amortization beginning on the fifth full fiscal quarter after
In
a portion of the net proceeds from our IPO.
Off-Balance-Sheet Arrangements
At no time have we maintained any relationships with unconsolidated entities or
financial partnerships, such as entities referred to as structured finance, or
special-purpose or variable interest entities, established for the purpose of
facilitating off-balance-sheet arrangements or other contractually narrow or
limited purposes. Further, we have never guaranteed any obligations of
unconsolidated entities or entered into any commitment or intent to provide
funding to any such entities.
New Accounting Standards
InJune 2016 , the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments, which significantly changes the way entities recognize credit losses and impairment of financial assets recorded at amortized cost. Currently, the credit loss and impairment model for loans and leases is based on incurred losses, and investments are recognized as impaired when there is no longer an assumption that future cash flows will be collected in full under the originally contracted terms. Under the new current expected credit loss ("CECL") model, the standard requires immediate recognition of estimated credit losses expected to occur over the remaining life of the asset. This standard also expands the disclosure requirements regarding an entity's assumptions, models and methods for estimating the allowance for loan and lease losses, and requires disclosure of the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination (i.e., by vintage year). ASU 2016-13 is effective for interim and annual periods in fiscal years beginning afterDecember 15, 2019 , with earlier adoption permitted. Entities are required to use a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted (modified-retrospective approach). The Company has developed a detailed implementation plan, selected a new software solution, reached accounting 66
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decisions on various matters, developed econometric models for our reasonable and supportable forecast period, selected key assumptions used in the model, and performed preliminary calculations. The Company continues to test and refine the CECL models, including its qualitative methodology to estimate losses that are not expected to be captured in the quantitative models. The Company is in the final stage of the independent third-party model validation. Based on multiple parallel testing performed using the Company's portfolio data, we expect the impact from the adoption of this standard to be immaterial to the Company's consolidated financial statements. InAugust 2018 , the FASB issued ASU 2018-15, Intangibles -Goodwill and Other -Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract, which aligns the requirements for capitalizing implementation costs in a cloud computing arrangement service contract with the requirements for capitalizing implementation costs incurred for an internal-use software license. Specifically, if a cloud computing arrangement is deemed to be a service contract, certain implementation costs are eligible for capitalization. The new guidance prescribes the balance sheet and income statement presentation and cash flow classification for the capitalized costs and related amortization expense. The amendments in this ASU should be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. The Company adopted this standard on a prospective basis onJanuary 1, 2020 . The adoption of ASU 2018-15 did not have a material impact on the Company's consolidated financial statements. InAugust 2018 , the FASB issued ASU 2018-13, "Fair Value Measurement (Topic 820): Disclosure Framework - Changes to Disclosure Requirements for Fair Value Measurements", which modified the disclosure requirements in ASC Topic 820 to add disclosures regarding changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements and the narrative description of measurement uncertainty. Certain disclosure requirements in ASC Topic 820 are also removed or modified. Certain disclosures in ASU 2018-13 would need to be applied on a retrospective basis and others on a prospective basis and early adoption is permitted. The Company has early adopted those provisions of the standard that permitted the removal or modification of certain disclosures effectiveJanuary 1, 2019 but deferred adoption of the additional new disclosures untilJanuary 1, 2020 . The adoption of this standard will modify disclosures in 2020 but will not have an impact on the Company's consolidated financial statements. InApril 2019 , the FASB issued ASU No. 2019-04, "Codification Improvements to Topic 326, Financial Instruments Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments," which clarifies and improves areas of guidance related to the recently issued standards on credit losses (ASU 2016-13), hedging (ASU 2017-12), and recognition of financial instruments (ASU 2016-01). The amendments generally have the same effective dates as their related standards. Impacts from the adoption of 2019-04 have been considered in the Company's overall CECL implementation and will be adopted concurrent with the adoption of ASU 2016-13. ASU 2017-12 and ASU 2016-01 are not applicable to the Company and therefore had no impact on the Company's consolidated financial statements.
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