VELOCITY FINANCIAL, INC. The following discussion should be read in conjunction with the information
included in our Annual Report on Form 10-K for the year ended
In addition, the statements and assumptions in this Quarterly Report that are not statements of historical fact are forward-looking statements within the meaning of federal securities laws. In particular, statements about our plans, strategies and prospects as well as estimates of industry growth for the next quarter and beyond are forward-looking statements. For important information regarding these forward-looking statements, please see the discussion below under the caption "Cautionary Note on Forward-Looking Statements."
References to "the Company," "Velocity," "we," "us" and "our" refer to
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 17 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. 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 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 ofSeptember 30, 2021 , has an average balance of approximately$353,000 . As ofSeptember 30, 2021 , our loan portfolio totaled$2.3 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 67.2%, and was concentrated in 1-4 unit residential rental loans, which we refer to as investor 1-4 loans, representing 50.6% of the UPB. For the three months endedSeptember 30, 2021 , the annualized yield on our total portfolio was 8.77%. We fund our portfolio primarily through a combination of committed and uncommitted secured warehouse facilities, securitizations, corporate debt and equity. The securitization market is our primary source of long-term financing. We have successfully executed 17 securitizations, resulting in a total of over$3.5 billion in gross debt proceeds fromMay 2011 throughSeptember 2021 .
We may also sell loans from time to time for cash in lieu of holding the loans in our loan portfolio.
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 facilities and securitizations and excludes our corporate debt. For the three months endedSeptember 30, 2021 , our annualized portfolio related net interest margin was 4.97%, an improvement of 14 basis points over the previous quarter mainly from the receipt of nonperforming loan interest and default interest from the resolutions of loans that went nonperforming in 2020 due to the COVID pandemic. 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 three months endedSeptember 30, 2021 , we generated pre-tax income and net income of$10.9 million and$8.0 million , respectively. 28 --------------------------------------------------------------------------------
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.
In
In lateMarch 2020 , we temporarily suspended our loan originations and purchases due to the business and economic uncertainties caused by the COVID-19 outbreak. In addition, effectiveMay 1, 2020 , we furloughed a significant number of our employees, mostly within our loan origination function.
On
In
We fully paid off the remaining
Recent Developments
At-The-Market Equity Offering Program
OnSeptember 3, 2021 , we entered into separate Equity Distribution Agreements withJMP Securities LLC andVirtu Americas LLC to establish an at-the-market equity offering program ("ATM Program") where we may issue and sell, from time to time, shares of our common stock. Our ATM Program allows for aggregate gross sales of our common stock of up to$50,000,000 provided that the number of shares sold under the ATM Program does not exceed 4,000,000. For the three months endedSeptember 30, 2021 , we sold 10,727 shares of our common stock under our ATM Program for net proceeds of$137,333 , net of$2,803 in commissions.
Continued 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 . 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, impact of new variant strains of the virus, and the long-term success of the vaccines, all of which are uncertain at this time and cannot be predicted. The full extent to which COVID-19 may continue to impact our business, financial condition or results of operations cannot be reasonably estimated at this time.
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 our financial statements are based upon reasonable assumptions given the information available at that time. These polices and estimates relate to the allowance for loan losses and deferred income tax assets and liabilities. Our critical accounting policies and estimates are described in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year endedDecember 31, 2020 as filed with theSEC .
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.
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-------------------------------------------------------------------------------- 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
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 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.
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 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.
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--------------------------------------------------------------------------------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 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.
Portfolio and Asset Quality
Key Portfolio Statistics
September 30, 2021 December 31, 2020 September 30, 2020
($ in thousands)
Total loans $ 2,271,294 $ 1,944,804 $ 1,986,344
Loan count 6,430 5,878 6,029
Average loan balance $ 353 $ 331 $ 329
Weighted average loan-to-value 67.2 % 66.1 % 66.2 %
Weighted average coupon 8.10 % 8.51 % 8.56 %
Nonperforming loans (UPB) $ 288,436 (A) $ 332,813 $ 314,727
Nonperforming loans (% of total) 12.70 % (A) 17.11 % 15.84 %
(A) Reflects the UPB of loans 90 days or more past due or placed on nonaccrual
status. Includes
on nonaccrual status as of
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 credit 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, except for
certain loans in our COVID-19 forbearance program, in bankruptcy, in
foreclosure, or not accruing interest 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.
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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
Three Months Ended September 30, 2021 :
Loan originations - held for investment 747 340,664 456 7.05 % 70.2 %
Loan originations - held for sale - - - (- )% (- )%
Total loan originations 747 $ 340,664 $ 456 7.05 % 70.2 %
Loan acquisitions - held for investment - - - (- )% (- )%
Total loans originated and acquired 747 $ 340,664 $ 456 7.05 % 70.2 %
Three Months Ended June 30, 2021 :
Loan originations - held for investment 683 256,512 376 7.32 % 69.7 %
Loan originations - held for sale - - - (- )% (- )%
Total loan originations 683 $ 256,512 $ 376 7.32 % 69.7 %
Loan acquisitions - held for investment 1 1,072 - 6.75 % 47.9 %
Total loans originated and acquired 684 $ 257,584 $ 377 7.32 % 69.6 %
Three Months Ended September 30, 2020 :
Loan originations - held for investment 19 8,094 426 7.35 % 68.8 %
Loan originations - held for sale - - - (- )% (- )%
Total loan originations 19 8,094 426 7.35 % 68.8 %
Loan acquisitions - held for investment - - - (- )% (- )%
Total loans originated and acquired 19 8,094 426 7.35 % 68.8 %
During the third quarter of 2021, we originated $340.7 million of loans, which
was an increase of $84.2 million , or 32.8% from the quarter ended June 30, 2021 .
We had no loan acquisitions during the quarter ended September 30, 2021 . Given
the suspension of loan production from mid-March through early September 2020
due to the dislocation caused by COVID-19, we had loan originations of $8.1
million during the quarter ended September 30, 2020 .
Loans Held for Investment and Loans Held for Investment at Fair Value
Our total portfolio of loans held for investment consists of both loans held for investment at amortized cost, which are presented in the consolidated balance sheet as loans held for investment, net, and loans held for investment at fair value, which are presented in the consolidated balance sheets 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: (in thousands) September 30, 2021 December 31, 2020 September 30, 2020 Unpaid principal balance $ 2,271,294 $ 1,931,875 $ 1,986,344 Valuation adjustments on FVO loans 16 (2 ) (33 ) Deferred loan origination costs 29,775 23,600 23,850 Total loans held for investment, gross 2,301,085 1,955,473 2,010,161 Allowance for credit losses (4,028 ) (5,845 ) (5,748 ) Loans held for investment, net $ 2,297,057 $
1,949,628 $ 2,004,413
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 the dates indicated:
September 30, 2021 December 31, 2020 September 30, 2020
($ in thousands) UPB % UPB % UPB %
Loans due in less than one year
5.2 % $ 86,029 4.3 %
Loans due in one to five years 23,142 1.0 79,398 4.1 115,465 5.8
Loans due in more than five years 2,119,309 93.3 1,752,452 90.7 1,784,850 89.9
Total loans held for investment $ 2,271,294 100.0 % $ 1,931,875 100.0 % $ 1,986,344 100.0 %
Allowance for Loan Losses
For the March 31, 2021 CECL estimate, the Company considered a COVID-19 adverse
stress scenario and a COVID-19 severe stress scenario, both with a five-quarter
reasonable and supportable forecast period followed by a four-quarter
straight-line reversion period. Management decided that using only the adverse
stress scenario did not factor for the unknown impact and success of the
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COVID vaccine initiative and the accelerated reopening of schools and
businesses. Management concluded that applying a 50% weight to the adverse
stress scenario and a 50% weight to the severe stress scenario, was appropriate
given the status of the pandemic at the end of
For theJune 30, 2021 CECL estimate, due to the improvements in theU.S. economy tempered with the unknown impact from the COVID variants in the second quarter of 2021, we decided it was no longer necessary to consider the 50% weighting of the COVID-19 adverse and severe stress scenarios. We instead used the COVID-19 adverse stress scenario with a five-quarter reasonable and supportable forecast period followed by a four-quarter straight-line reversion period. For theSeptember 30, 2021 CECL estimate, we used the COVID-19 adverse stress scenario with a six-quarter reasonable and supportable forecast period followed by a four-quarter straight-line reversion period. We increased the reasonable and supportable forecast period from five-quarters to six-quarters in light of the lingering effects of the COVID-19 pandemic, including increased mandated vaccinations, lower than forecasted employment numbers, expiring unemployment benefits, continued disruptions in the economic supply chain, and concerns of the Delta variant combined with an upcoming flu season. The various scenarios, the weighting of scenarios, as well as the forecast period and reversion to historical loss, is subject to change as conditions in the market change and the Company's ability to forecast economic events evolves. Our allowance for loan losses as ofSeptember 30, 2021 remained at$4.0 million , consistent with the balance atJune 30, 2021 , and decreased by$1.7 million as compared to$5.7 million as ofSeptember 30, 2020 . The decreases in allowance for credit losses fromSeptember 30, 2020 was primarily attributable to the improvements in theU.S. economy resulting from the reopening of businesses assumed in our loan loss macroeconomic model projections. 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. To estimate the allowance for credit losses in our loans held for investment portfolio, we follow a detailed internal review 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 credit losses over the periods indicated:
Three Months Ended September 30, Nine Months Ended September 30,
2021 2020 2021 2020
Allowance for credit losses:
Beginning balance $ 3,963 $ 5,220 $ 5,845 $ 2,240
Impact of adopting ASC 326 - - - 137
Provision for loan losses 228 1,574 (668 ) 4,663
Charge-offs (163 ) (1,046 ) (1,149 ) (1,292 )
Ending balance $ 4,028 $ 5,748 $ 4,028 $ 5,748
Total loans held for investment
(UPB), excluding FVO (1) $ 2,269,950 $
1,982,984
0.18 % 0.29 % 0.18 % 0.29 %
(1) Reflects the UPB of loans held for investment excluding loans held for
investment at fair value (FVO). Loans held for investment, net on the
consolidated balance sheets is net of allowance for credit losses of $4.0
million , and net deferred loan origination fees/costs of $29.8 million as
of September 30, 2021 .
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Credit Quality - Loans Held for Investment and Loans Held for Investment at Fair Value
The following table provides delinquency information on our loans held for
investment and loans held for investment at fair value by UPB as of the dates
indicated:
COVID-19 COVID-19 COVID-19
September 30, 2021 (A) Forbearance June 30, 2021 (A) Forbearance September 30, 2020 (A) ForbearancePerforming/Accruing: Current$ 1,878,555 82.7 %$ 228,001 $ 1,645,019 79.8 %$ 227,682 $ 1,474,076 74.2 %$ 266,446 30-59 days past due 81,893 3.6 16,669 69,165 3.4 14,947 108,601 5.5 42,609 60-89 days past due 22,410 1.0 5,273 32,484 1.6 9,148 74,351 3.7 52,636 90+ days past due - - - 152 0.0 152 14,589 0.7 14,590 Total Performing Loans 1,982,858 87.3 249,943 1,746,820 84.7 251,929 1,671,617 84.2 376,281 Nonperforming/Nonaccrual: <90 days past due 23,195 1.0 5,559 20,740 1.0 4,622 23,502 1.2 603 90+ days past due 48,365 2.1 16,332 50,637 2.4 19,330 119,248 6.0 31,546 Bankruptcy 19,983 0.9 6,407 17,659 0.9 6,560 8,646 0.4 1,620 In foreclosure 196,893 8.7 41,503 226,506 11.0 60,001 163,331 8.2 1,114 Total nonperforming loans 288,436 12.7 69,801 315,542 15.3 90,513 314,727 15.8 34,883
Total loans held for investment
100.0 % $ 411,164 (A) Balance includes
of
Other than loans in the COVID-19 forbearance program, loans that are 90+ days past due, in bankruptcy, in foreclosure, or not accruing interest are considered nonperforming loans. Nonperforming loans were$288.4 million , or 12.7% of our held for investment loan portfolio as ofSeptember 30, 2021 , compared to$315.5 million , or 15.3% as ofJune 30, 2021 , and$314.7 million , or 15.8% of the held for investment loan portfolio as ofSeptember 30, 2020 . The decrease in total nonperforming loans as ofSeptember 30, 2021 as compared toJune 30, 2021 was primarily attributed to loan resolutions by our Special Servicing department, along with improvement in theU.S. economy. 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 tables summarize the resolution activities of loans that became nonperforming prior to the beginning of the periods indicated or became nonperforming and subsequently resolved during the periods indicated. We resolved$55.2 million and$10.9 million of long-term and short-term non-performing loans during the quarter endedSeptember 30, 2021 and 2020, respectively. Including REO resolutions, we realized net gains of$2.1 million and$0.4 million during the quarter endedSeptember 30, 2021 and 2020, respectively. This is largely the result of collecting default interest and prepayment penalties in excess of the contractual principal and interest due on loans. The table below includes nonperforming loan resolutions for our long-term loans. Three Months Ended Long-Term Loans September 30, 2021 June 30, 2021 September 30, 2020 Gain / Gain / Gain / ($ in thousands) UPB (Loss) UPB (Loss) UPB (Loss) Resolved - paid in full$ 13,353 $ 1,251 $ 21,925 $ 1,446 $ 9,705 $ 728 Resolved - paid current 7,722 79 14,949 219 1,152 24 Resolved - REO sold (1) 4,680 31 947 (2 ) 1,628 (312 ) Total resolutions$ 25,755 $ 1,361 $ 37,821 $ 1,663 $ 12,485 $ 440 Recovery rate on resolved nonperforming UPB 105.3 % 104.4 % 103.5 %
Note (1) There was an REO property held since
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The table below includes nonperforming loan resolutions for our short-term
loans, now being held for investment, and also includes loans that were granted
a COVID-19 forbearance in 2020. Prior to January 1, 2021 , nonperforming loan
resolutions presented only consisted of long-term nonperforming loans held for
investment since the short-term loans, or loans with a maturity of two-year or
less, were being held for sale until later in 2020. The short-term loans do not
require prepayment fees and usually result in a lower gain when paid in full, as
compared to long term loans.
Three Months Ended
Short-Term and
Forbearance Loans September 30, 2021 June 30, 2021
Gain / Gain / Gain /
($ in thousands) UPB (Loss) UPB (Loss) UPB (Loss)
Resolved - paid in full
29 7,794 59 - -
Resolved - REO sold 104 47 164 (73 ) - -
Total resolutions $ 34,205 $ 740 $ 21,475 $ 668 $ - $ -
Recovery rate on
resolved
nonperforming UPB 102.2 % 103.1 % N/A
Our charge-offs incurred have been small as a percentage of nonperforming loans
held for investment. The table below shows our actual loan losses for the
periods indicated.
Nine Months Ended Six Months Ended Nine Months Ended
($ in thousands) September 30, 2021 June 30, 2021 September 30, 2020
Average nonperforming loans for the
period (1) 288,778 334,120 311,136
Charge-offs 1,149 987 1,292
Charge-offs / Average nonperforming
loans for the period (1) 0.53 % (2) 0.59 % (2) 0.55 % (2)
(1) Reflects the monthly average of nonperforming loans held for investment
during the period.
(2) Reflects annualized year-to-date charge-offs to average nonperforming loans
for the period.
Concentrations - Loans Held for Investment
As ofSeptember 30, 2021 , our held for investment loan portfolio was concentrated in investor 1-4 loans, representing 50.6% of the UPB. Mixed used properties represented 13.3% 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 23.2% inCalifornia , 22.1% inNew York , 13.3% inFlorida , and 7.8% inNew Jersey . Property Type September 30, 2021 ($ in thousands) Loan Count UPB % of Total UPB Investor 1-4 3,829$ 1,150,029 50.6 % Mixed use 793 302,459 13.3 Multifamily 444 202,535 8.9 Retail 441 197,326 8.7 Office 306 129,305 5.7 Warehouse 231 150,693 6.6 Other(1) 386 138,947 6.1 Total loans held for investment 6,430$ 2,271,294 100 % (1) All other properties individually comprise less than 5.0% of the total unpaid principal balance. Geography (State) September 30, 2021 ($ in thousands) Loan Count UPB % of Total UPB California 957$ 527,618 23.2 % New York 1008 501,997 22.1 Florida 955 302,169 13.3 New Jersey 663 177,431 7.8 Other(1) 2,847 762,079 33.6 Total loans held for investment 6,430$ 2,271,294 100 %
(1) All other states individually comprise less than 5.0% of the total unpaid
principal balance.
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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 credit 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 ofSeptember 30, 2021 , our REO included 35 properties with a lower of cost or estimated fair value of$17.9 million compared to 40 properties with a lower of cost or estimated fair value of$20.0 million as ofJune 30, 2021 . Key Performance Metrics Three Months Ended September 30, June 30, 2021 September 30, ($ in thousands) 2021 (1) (1) 2020 (1) Average loans$ 2,139,789 $ 2,022,486 $ 2,016,414 Portfolio yield 8.77 % 8.90 % 8.21 % Average debt - portfolio related 1,815,442 1,710,276 1,764,975 Average debt - total company 1,988,376 1,876,611 1,842,975 Cost of funds - portfolio related 4.48 % 4.81 % 5.07 % Cost of funds - total company 4.99 % 5.30 % 5.27 % Net interest margin - portfolio related 4.97 % 4.83 % 3.77 % Net interest margin - total company 4.13 % 3.98 % 3.39 % Charge-offs/Average loans held for investment 0.01 % 0.05 % 0.05 % Pre-tax return on equity (2) 18.23 % 22.57 % 9.60 % Return on equity (2) 13.38 % 16.56 % 6.65 % (1) Percentages are annualized. (2) Pre-tax return on equity and return on equity were higher during the
quarter ended
2021 due to more loans sold during the quarter ended
Management decided to securitize more loans for the quarter ended September
30, 2021. The gain on sale of loans, a component of gain on disposition of
loans, was
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. 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 fluctuations in our portfolio yield over the periods shown was primarily driven by loans placed on non-accrual status during the periods.
Average Debt -
Portfolio-related debt consists of borrowings related directly to financing our loan portfolio, which includes our warehouse facilities and securitizations. Total company debt consists of portfolio- related debt and corporate debt. The measures presented here reflect 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.
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Our portfolio related cost of funds decreased to 4.48% for the three months
ended
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 below, our portfolio related net interest margin increased from 4.83% for the three months endedJune 30, 2021 and 3.77% for the three months endedSeptember 30, 2020 to 4.97% for the three months endedSeptember 30, 2021 due to strong resolutions on nonperforming loans and a modest improvement in the nonperforming loans ratio to total loans.
Our total company net interest margin increased to 4.13% for the three months
ended
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:
Three Months Ended
September 30, 2021 June 30, 2021 September 30, 2020
Interest Average Interest Average Interest Average
Average Income / Yield / Average Income / Yield / Average Income / Yield /
($ in thousands) Balance Expense Rate (1) Balance Expense Rate (1) Balance Expense Rate (1)
Loan portfolio:
Loans held for sale $ 2,284 $ 11,524 $ -
Loans held for investment 2,137,505 2,010,962 2,016,414
Total loans $ 2,139,789 $ 46,923 8.77 % $ 2,022,486 $ 44,978 8.90 % $ 2,016,414 $ 41,374 8.21 %
Debt:
Warehouse facilities $ 182,383 2,365 5.19 % $ 166,981 2,361 5.66 % $ 22,306 $ 703 12.61 %
Securitizations 1,633,059 17,956 4.40 % 1,543,295 18,205 4.72 % 1,742,669 21,644 4.97 %
Total debt - portfolio related 1,815,442 20,321 4.48 % 1,710,276 20,566 4.81 % 1,764,975 22,347 5.07 %
Corporate debt 172,934 4,488 10.38 % 166,335 4,309 10.36 % 78,000 1,913 9.81 %
Total debt $ 1,988,376 $ 24,809 4.99 % $ 1,876,611 $ 24,875 5.30 % $ 1,842,975 $ 24,260 5.27 %
Net interest spread -
portfolio related (2) 4.29 % 4.08 % 3.14 %
Net interest margin -
portfolio related 4.97 % 4.83 % 3.77 %
Net interest spread -
total company (3) 3.78 % 3.59 % 2.94 %
Net interest margin -
total company 4.13 % 3.98 % 3.39 %
(1) Annualized.
(2) 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.
(3) 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
Our annualized charge-off rate for the three months endedSeptember 30, 2021 decreased to 0.01% from 0.05% for the three months endedJune 30, 2021 andSeptember 30, 2020 . The decrease in the charge-off rate was primarily attributable to the decrease in charge-offs during the period endedSeptember 30, 2021 . The charge-offs rate reflects year-to-date annualized charge-offs as a percentage of average loans held for investment for the respective quarter. We do not record charge-offs on our loans held for sale which are carried at the lower of cost or estimated fair value. 37 --------------------------------------------------------------------------------
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 stockholders' equity over the specified period. Pre-tax return on equity and return on equity were higher during the quarter endedJune 30, 2021 , compared to the quarter endedSeptember 30, 2021 , due to more loans sold during the quarter endedJune 30, 2021 . Management decided to securitize more loans for the quarter endedSeptember 30, 2021 . The gain on sale of loans, a component of gain on disposition of loans, was$2.2 million for the quarter endedJune 30, 2021 , compared to$0.5 million for the quarter endedSeptember 30, 2021 . Three Months Ended ($ in thousands) September 30, 2021 June 30, 2021 September 30, 2020 Income before income taxes (A) $ 10,927$ 12,885 $ 5,025 Net income (B) 8,022 9,453 3,481 Monthly average balance: Stockholders' equity (C) 239,790 228,314 209,468 Pre-tax return on equity (A)/(C) (1) 18.2 % 22.6 % 9.6 % Return on equity (B)/(C) (1) 13.4 % 16.6 % 6.6 % (1) Annualized.
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 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
Interest expense on corporate debt primarily consists of interest expense paid with respect to the 2019 Term Loan and the 2021 Term Loan, as reflected on our consolidated balance sheets, and the related amortization of deferred debt issuance costs.
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
EffectiveJanuary 1, 2020 , we adopted ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments replacing the incurred loss accounting approach with the current expected credit loss (CECL) approach. Under the CECL methodology, the allowance for credit losses is calculated using a third-party model with our historical loss rates by segment, loans position as of the balance sheet date, and assumptions from us. 38 --------------------------------------------------------------------------------
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 a loan charge-off. 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. Changes in fair value subsequent to initial recognition of fair value loans are reported as unrealized gain/(loss) on fair value loans, a component of other operating income within the consolidated statements of income.
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. Changes in fair value subsequent to initial recognition are reported as unrealized gains/(losses) on interest-only securities. Valuation Allowance on Loans Held for Sale.Loans held for sale are carried at the lower of cost or estimated fair value. Adjustments to the carrying value of loans held for sale to estimate fair value are reported as valuation allowance.
Fee Income. In certain situations, we collect fee income by originating loans and realizing miscellaneous 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.
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.
39
--------------------------------------------------------------------------------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.
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