EDGAR 10-K Filing

Company CIK: 1692376
Filing Year: 2022
Filename: 1692376_10-K_2022_0000950170-22-003636.json

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ITEM 1. BUSINESS
Item 1. Business.
Our Company
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 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 18 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 attractive 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.
We believe there is a substantial and durable market opportunity for investor real estate loans across 1-4 unit residential rental and small commercial properties, and that our institutionalized approach to serving these fragmented market segments underpins our long-term business strategy. Our growth to date has validated the need for scaled lenders with dedication to individual investors who own ten or fewer properties, a base which we believe represents the vast majority of activity across our core market. According to data from the U.S. Census Bureau, since 1965, the U.S. home rentership rate (the inverse of the home ownership rate) has averaged approximately 35%. According to an estimate published by Zillow in January 2021, the value of the U.S. residential housing sector is over $36 trillion. Ownership of residential properties for rent has historically been concentrated among smaller investors. According to data published by the Urban Institute in August and October 2017, an estimated 45% of single-family rental units (attached or detached) are owned by investors who own just one unit and an estimated 87% of investors own 10 or fewer units, while institutional ownership comprises less than 3% of the market.
Our primary 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 and improved brand awareness. We believe our reputation and 18-year history within our core market position us well to capture future growth opportunities.
We make loans for business purposes only, which we believe limits our exposure to the regulatory constraints of consumer lending. We do not make consumer loans or lend on raw land.
On January 16, 2020, we converted from a limited liability company to a corporation incorporated under the law of the State of Delaware by filing a certificate of conversion with the Secretary of State of the State of Delaware and changed our name from Velocity Financial, LLC to Velocity Financial, Inc.
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 in the United States. As a result of the spread of COVID-19, economic uncertainties have arisen which have negatively impacted our financial condition, results of operations and cash flows. The further extent of the impact of COVID-19 on our operational and financial performance will depend on certain developments, including the duration and spread of any subsequent outbreaks and their impact on our customers, employees and vendors, the impact of a new mutant strain of the virus, and the long-term success of vaccines, all of which remain uncertain at this time and cannot be predicted. In order to protect our employees, we have been primarily working remotely since March 2020. In addition, we have implemented COVID-19 related protective measures and protocols to allow a limited number of staff to work from our offices located across the country. We will continue to evaluate our business strategy in light of rapidly changing market conditions.
Our Competitive Advantages
We believe that the following competitive advantages enhance our ability to execute our business strategy and position us well for future growth:
Established Franchise with Strong Brand Recognition
We believe our reputation and deep history within the real estate lending community position us as a preferred lender for mortgage brokers. We have been originating and acquiring loans in our core market since our inception in 2004, making us a recognizable brand with a proven ability to execute. Additionally, we have successfully executed nineteen securitizations of our investor real estate loans, raising over $4.0 billion in gross debt proceeds between 2011 and the year ended December 31, 2021. We have a keen understanding of this securitization market, including complicated structural issues, investor expectations and rating agency requirements. We executed our sixteenth through nineteenth securitizations in 2021. We believe this demonstrates that we have a strong reputation with investors in the securitization market, which enables us to maintain efficient access to debt capital that ultimately improves our ability to offer competitive pricing to our borrowers.
Customized Technology and Proprietary Data Analytics
We have invested in and customized automated systems to support our use of data analytics which drives our lending process. We believe the investor real estate lending market requires a highly-specialized skill set and infrastructure. To effectively compete and execute on a sustainable long-term business strategy, lenders must control the cost to originate and manage loans without sacrificing credit quality. We believe our investment in technology and use of data analytics helps us achieve these critical objectives and positions our business for sustainable, long-term growth.
We apply the same asset-driven underwriting process to all of the loans in our portfolio, regardless of whether we originate or acquire these loans. Our credit and underwriting philosophy encompasses individual borrower and property due diligence, taking into consideration several factors. Our access to 18 years of proprietary data allows us to perform analytics that inform our lending decisions efficiently and effectively, which we believe is a strong competitive advantage.
Large In-Place Portfolio with Attractive, Long-Term Financing
We believe our in-place portfolio provides a significant and stable income stream for us to invest in future earnings growth. The majority of our loans are structured to provide for interest rate protection, by floating after an initial fixed-rate period, subject to a floor equal to the starting fixed rate. The loans are mainly financed with long-term fixed-rate debt, resulting in a spread that could increase over time, but not decrease. As a result, our in-place portfolio generally benefits from rising interest rates. We generated $76.0 million in net interest income for the year ended December 31, 2021 from our in-place portfolio. Excluding the interest expense paid on our corporate debt, we generated $96.6 million in portfolio related net interest income, representing a 4.54% portfolio related net interest margin, during the year ended December 31, 2021.
Our In-House Asset Management Results in Successful Loss Mitigation
Direct management of individual loans is critical to avoiding or minimizing credit losses and we work with our third-party primary servicers with whom we have developed strong relationships to emphasize disciplined loan monitoring and early contact with delinquent borrowers to resolve delinquencies. We have a dedicated asset management team that, augmented with primary servicing from our loan servicers, focuses exclusively on resolving delinquent loans. Our hands-on approach enables us to generally preserve the value of our assets and helps us to minimize losses. We believe this expertise, combined with our outsourced servicing relationships, gives us a distinct competitive advantage.
Our Experienced Management Team
Led by co-founder and Chief Executive Officer Christopher Farrar, our management team averages more than 25 years of experience in the financial services and real estate lending industries, including extensive experience in commercial and residential lending, structured finance and capital markets. We have successfully navigated both positive and negative economic cycles and retained our core team of experienced professionals in appraisal, underwriting, processing and production, while bolstering our finance and asset management team with professionals possessing extensive experience in financial reporting and real estate management. We believe our in-depth knowledge of our core market provides a distinct competitive advantage.
Our Growth Strategy
The market for investor real estate loans is large and highly fragmented. We have built a dedicated and scalable national lending platform focused specifically on serving this market and believe our capabilities position us well to maintain our reputation as a preferred lender in this market. Our organic growth strategy is predicated on further penetrating our existing network of mortgage brokers and expanding our network with new mortgage brokers. A key element of our implementation of this strategy is the growth and development of our team of account executives, as well as targeted marketing initiatives. We will continue to supplement the extension of our broker network with the development of new products to support the evolving needs of borrowers in our core market.
We continue to opportunistically pursue inorganic growth strategies such as acquiring portfolios of loans that meet our investment criteria and acquisitions of businesses that align with our strategic vision.
Further Penetrate Our Existing Mortgage Broker Network
We strive to be the preferred lender within our network of approved mortgage brokers. We have developed a strong reputation in the market for high quality execution and timely closing, which we believe are the most important qualities our mortgage brokers value in selecting a lender. There is significant opportunity for us to further penetrate the approximately 3,100 mortgage brokers with whom we have done business over the last five years. Approximately 85% of loan originators originated five or fewer loans with us during the year ended December 31, 2021. We believe this presents a compelling opportunity for us to capture incremental volume from our existing broker network.
Expand Our Network with New Mortgage Brokers
We believe that our targeted sales effort, combined with consistent high-quality execution, positions us well to continue adding to the network of mortgage brokers that rely on us to serve their borrower clients.
Despite the adverse macroeconomic conditions caused by the COVID-19 pandemic, we funded 3,105 loans sourced by approximately 1,000 different mortgage brokers during the year ended December 31, 2021. We believe that represents a small portion of the mortgage originators in the United States, which consisted of approximately 688,000 state-licensed mortgage originators by the end of 2020 according to the Nationwide Multistate Licensing System. The size of the mortgage broker market presents an attractive opportunity for us to capture significant growth with very small increases in the share of mortgage brokers that recognize our platform capabilities and utilize us as a preferred lender in our core market.
Develop New Products
Our primary products are a 30-year amortizing term loan with a three-year fixed-rate period which floats at a spread to the prime rate thereafter subject to a floor equal to the starting fixed rate, and a 30-year fixed-rate amortizing term loan. These loans comprised 94.9% of our loan originations during the year ended December 31, 2021. These products are used by borrowers to finance stabilized long-term real estate investments. We believe these products have strong receptivity in our market, as evidenced by our success in growing loan originations over time. Since our inception, we have continued to expand our product offering in response to developing market opportunities and the evolving financing needs of our broker network. For example, in 2013, in response to the increased demand for rental properties, we moved aggressively into the market for 1-4 unit residential rental loans, which comprised 49.0% of our held for investment loan portfolio as of December 31, 2021.
In March 2017, we began originating short-term, interest-only loans to be used for acquiring, repositioning or improving the quality of 1-4 unit residential investment properties. This product typically serves as an interim solution for borrowers and/or properties that do not meet the investment criteria of our primary 30-year product. The short-term, interest-only loan allows borrowers to address any qualifying issues with their credit and/or the underlying property before bridging into a longer-term loan. In June 2018, we added a second short-term, interest-only loan product which allows borrower draws for rehabbing residential rental property. Historically, we have aggregated and sold most of these short-term, interest-only loans at a premium to par to institutional investors, which has generated attractive income for us with limited capital while also allowing us to establish an underwriting track record and monitor the performance of these loans. In December 2021 we added a new HUD multi-family and healthcare loan product offering with our acquisition of a majority interest in Century Health & Housing Capital, LLC (“Century”).
Opportunistically Acquire Portfolios of Loan and Acquire Strategically-Aligned Businesses
We continually assess opportunities to acquire portfolios of loans that meet our investment criteria. Over the past 18 years, our management team has developed relationships with many financial institutions and intermediaries that have been active investor real estate loan originators or investors. We believe that our experience, reputation, and ability to effectively manage these loans makes us an attractive buyer for this asset class, and we are regularly asked to review pools of loans available for purchase. 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 augments our origination business, but also provides a counter-cyclical benefit to our overall business. In light of market disruptions caused by COVID-19, we have begun to increase our focus on this growth strategy.
On December 28, 2021, the Company acquired an 80% ownership interest in Century Health & Housing Capital, LLC (“Century”), paying a cash purchase price of $12.8 million. Century is a licensed “Ginnie Mae” issuer/servicer that provides government-insured Federal Housing Administration (FHA) mortgage financing for multifamily housing, senior housing and long-term care/assisted living facilities. Century originates loans through its borrower-direct origination channel and services the loans through its in-house servicing platform, which enables the formation of long-term relationships with its clients and drives strong portfolio retention. Century earns origination fees and servicing fees from the mortgage servicing rights on its servicing portfolio.
Our Portfolio
Loans Held for Investment
Our typical investor real estate loan is secured by a first lien on the underlying property with the added protection of a personal guarantee and, based on the loans in our portfolio as of December 31, 2021, has an average balance of approximately $369,000. As of December 31, 2021, our portfolio of loans held for investment totaled $2.5 billion of unpaid principal balance, or UPB, on properties in 45 states and the District of Columbia. Of the 6,769 loans held for investment as of December 31, 2021, 98.6% of the portfolio, as measured by UPB, was attributable to our loan origination business, while the remaining 1.4% of the portfolio, or 78 loans, totaling $35.4 million in UPB, were related to acquisitions. During the years ended December 31, 2021 and 2020, we originated 3,105 and 955 loans to be held for investment totaling $1.3 billion and $338.8 million, respectively.
As of December 31, 2021, 90.6% of our loans held for investment, as measured by UPB, were fully-amortizing over 30 years. The principal amount of a fully-amortizing loan is repaid ratably over the term of the loan, as compared to a balloon loan where all, or a substantial portion of, the original loan amount is due in a single payment at the maturity date. We believe that fully-amortizing loans face a lower risk of default than balloon loans, as the final payment due under the balloon loan may require the borrower to refinance or sell the property.
We target investor real estate loans with loan-to-value ratios, or LTVs, between 60% and 75% at origination as we believe that borrower equity of 25% to 40% provides significant protection against credit losses. As of December 31, 2021, our loans held for investment had a weighted average LTV at origination of 67.6%. Additionally, as of December 31, 2021, borrowers personally guaranteed 100.0% of the loans in our held for investment portfolio and had a weighted average credit score at origination of 713, excluding the 1.34% of loans for which a credit score is not available.
The following charts illustrate the composition of our loans held for investment as of December 31, 2021:
(*)	Percentages may not sum to 100% due to rounding.
(1)Portfolio stratifications based on unpaid principal balance for loans held for investment as of December 31, 2021.
(2)Represents LTV at origination for population of loans held for investment as of December 31, 2021. In instances where LTV at origination is not available for an acquired loan, the LTV reflects our best estimate of value at time of acquisition.
(3)The approximately 2% portion of our loans held for investment with an LTV greater than 75% consists primarily of acquired loans.
We typically do not lend on any property located in a city with a population less than 25,000 and outside a 25-mile radius of a city with a population in excess of 100,000. We generally prefer to lend in larger metropolitan statistical areas.
Loans Held for Sale
As of December 31, 2021, our portfolio of loans held for sale consisted of 195 loans with an aggregate UPB of $87.4 million and carried a weighted average original loan term of 145 months and a weighted average coupon of 7.1%. As of December 31, 2021, 100% of our held for sale portfolio, as measured by UPB, was attributable to our loan origination business.
In line with our overall investment strategy, we target loans held for sale with LTVs between 60% and 75% at origination as we believe that borrower equity of 25% to 40% provides significant protection against credit losses. As of December 31, 2021, our loans held for sale had a weighted average LTV at origination of 69.3%. Additionally, as of December 31, 2021, borrowers personally guaranteed 100% of the loans in our held for sale portfolio and had a weighted average credit score at origination of 730, excluding any loan for which a credit score is not available.
The following charts illustrate the composition of our loans held for sale as of December 31, 2021:
(*)	Percentages may not sum to 100% due to rounding.
(1)Portfolio stratifications based on unpaid principal balance for loans held for sale as of December 31, 2021.
(2)Represents LTV at origination for population of loans held for sale as of December 31, 2021.
Our Financing Strategy
We typically finance our new loan originations using warehouse facilities. Once we have originated between approximately $175 million and $400 million in new loans, we securitize the loans through a real estate mortgage investment conduit, or REMIC, structure and issue the bonds to third parties through individual trust vehicles. All of our securitizations are issued as private placements pursuant to Rule 144A under the Securities Act and utilize a REMIC structure except for the 2020 MC1 transaction which was not a REMIC and issued one class of bonds treated as debt for tax purposes. These REMIC transactions create significant U.S. GAAP versus tax differences as the U.S. GAAP treatment is a debt financing, however the IRS requires sale treatment and requires us to recognize taxable income to the extent the fair market value exceeds our cost basis, the payment of which creates a deferred tax asset. We are the sole beneficial interest holder of each of the trusts, through our wholly-owned subsidiaries. Proceeds from the issuance of the securities are then used to pay down the balances on our warehouse facilities. As of December 31, 2021, we had successfully executed nineteen securitizations of our investor real estate loans, raising over $4.0 billion in gross debt proceeds. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources” for additional information about our warehouse repurchase facilities and securitizations.
In February 2021, we entered into a five-year $175.0 million syndicated corporate debt agreement (“2021 Term Loan”). The 2021 Term Loan bears interest at a rate equal to one-month LIBOR plus 8.00%, with a 1.00% LIBOR floor, and matures in February 2026. A portion of the net proceeds from the 2021 Term Loan was used to redeem all the outstanding corporate debt owing pursuant to our 2019 debt agreement with Owl Rock Capital Corporation (“2019 Term Loan”). The remaining portion of the net proceeds from the 2021 Term Loan will be used for loan originations and general corporate purposes.
Depending on market conditions, we may increase leverage on our investments with an amount of debt we deem prudent, subject to applicable risk retention rules. Our decision to use leverage to finance our assets will be based on our assessment of a variety of factors, including, among others, the anticipated liquidity and price volatility of the assets in our investment portfolio, the potential for losses and extension risk in our portfolio, the availability of credit at favorable prices, the credit quality of our assets and the outlook for our borrowing costs relative to the interest income earned on our assets and, where applicable, regulatory requirements with respect to securitizations.
Going forward, our financing sources may include borrowings in the form of additional bank credit facilities (including term loans and revolving facilities), additional warehouse repurchase facilities, structured financing arrangements, future securitizations and public and private equity and debt issuances, in addition to transaction or asset-specific funding arrangements. We intend to use leverage primarily to finance our portfolio and not for speculating on changes in the level of interest rates. We are not required to employ specific debt levels, and we believe the appropriate leverage for the particular assets we may finance depends on the factors discussed above.
We expect to continue financing our loan portfolio with equity and our financing arrangements, including warehouse lines for short-term financing and securitizations for long-term financing. We believe using securitizations to finance our investor real estate loans fits well with our strategy of holding interest-earning assets over the long-term to earn a spread. This type of financing structure more closely matches the asset duration with the duration of the financing.
Competition
The business of financing investor real estate loans is competitive. We compete with specialty finance companies, regional and community banks and thrifts, public and private entities, institutional investors, mortgage bankers, insurance companies, investment banking firms, and other financial institutions, and we expect that additional competitors may be organized or otherwise enter our core market in the future. 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, we may not be able to achieve our business goals or expectations due to the competitive risks that we face. 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. Such rates may be impacted by the competitor’s size, cost of funds, and access to funding sources that are not available to us.
Government Regulation
Certain states in which we conduct business require approval, registration or licensing. Typically, the mortgage broker that originates the loan that we make, fund or acquire is licensed or exempt from licensing in the state where the loan is made. We also hold a Federal Housing Administration, or FHA, Title II approval from the Department of Housing and Urban Development, which permits us to make certain government-insured loans. With the acquisition of Century, we are now a licensed “Ginnie Mae” issuer/servicer that provides government-insured Federal Housing Administration (FHA) mortgage financing for multifamily housing, senior housing and long-term care/assisted living facilities. As a licensed Ginnie Mae issuer/servicer, we are subject to GNMA’s regulations.
We may be required to obtain licenses to originate investor real estate loans in the various additional jurisdictions in which we conduct our business or to acquire investor real estate loans. If we are required to obtain additional licenses to originate or acquire investor real estate loans, the process may be costly and could take several months. There is no assurance that we will obtain the licenses required or that we will not experience significant delays in seeking these licenses. Furthermore, we may be subject to various reporting and other requirements to maintain these licenses, and there is no assurance that we may satisfy those requirements. Our failure to maintain or obtain licenses may restrict our investment options and could harm our business.
Human Capital Resources
As of December 31, 2021, we had 215 employees, a 23% increase from the prior year. None of our employees are represented by a labor union. The increase in our employees was a result of our origination growth over the prior year.
A driving force in our ability to generate revenue comes from the work of our Account Executives, or AEs. Our AEs generate business for us through their relationships with third-party brokers. Our ability to retain and attract AEs is essential to the growth of our business. A significant number of our employees are AEs, representing 38% of our workforce at year-end.
Our employment strategy is to create a culture that allows us to attract and retain the very best talent in our industry, provide competitive pay and benefits, and to ensure a healthy work environment comprised of an employee base that is considerate, collaborative, productive and driven. We are committed to building a great place to work for all of our employees. We provide an hourly wage or salary to our employees as well as the potential for discretionary bonuses. AEs are also eligible to receive additional quarterly bonuses based partially on the AEs revenue-generating results during the quarter.
While we have not adopted any diversity quotas, 64% of our employees are men and 36% are women.
We are committed to the health, safety, and wellness of our employees. In response to the pandemic, we implemented precautionary policies and significant operational changes to protect and support our employees, including remote working. As of December 31, 2021, substantially all our employees have been able, and continue, to work remotely.
We and our employees are also committed to improving the communities in which we work and live. Through our charitable donations and Velocity Volunteers, we pick local charitable causes and projects to support and encourage our employees to donate their time and needed materials.
Our Corporate Information and History
Velocity Financial, Inc. is a corporation incorporated under the law of the State of Delaware.
On January 22, 2020, we completed the initial public offering (“IPO”) of our common stock, par value $0.01 per share (our “common stock”). Shares of our common stock trade on the New York Stock Exchange under the symbol “VEL.”
Our offices are located at 30699 Russell Ranch Road, Suite 295, Westlake Village, California 91362, and the telephone number of our offices is (818) 532-3700. Our internet address is www.velfinance.com. Our internet website and the information contained therein or connected to or linked from our internet web site are not incorporated information and do not constitute a part of this Annual Report or any amendment thereto.

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ITEM 1A. RISK FACTORS
Item 1A. Risk Factors.
Intentionally omitted pursuant to smaller reporting company reduced disclosure requirements.

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ITEM 1B. UNRESOLVED STAFF COMMENTS
Item 1B. Unresolved Staff Comments.
None.

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ITEM 2. PROPERTIES
Item 2. Properties.
Our corporate headquarters are located in leased space at 30699 Russell Ranch Road, Suite 295, Westlake Village, CA 91362.

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ITEM 3. LEGAL PROCEEDINGS
Item 3. Legal Proceedings.
From time to time, in the ordinary course of business, we are involved in various judicial, regulatory or administrative claims, proceedings and investigations. These proceedings and actions may include, among other things, allegations of violation of banking and other applicable regulations, competition law, labor laws and consumer protection laws, as well as claims or litigation relating to intellectual property, securities, breach of contract and tort. We intend to defend ourselves vigorously against any pending or future judicial, regulatory or administrative claims or proceedings. Although occasional adverse decisions or settlements may occur, our management does not believe that the final disposition of any currently pending or threatened matter will have a material adverse effect on our business, financial position, results of operations or cash flows.

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ITEM 4. MINE SAFETY DISCLOSURE
Item 4. Mine Safety Disclosures.
Not applicable.
PART II

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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information
Our common stock is listed on The New York Stock Exchange under the symbol VEL.
As of February 9, 2022, there were approximately 1,500 beneficial holders of our common stock.
Dividend Policy
We have not declared or paid cash dividends to date on our common stock and we do not intend to pay dividends for the foreseeable future. Any future determination to declare dividends will be made at the discretion of our board of directors and will depend on our financial condition, operating results, capital requirements, general business conditions, limitations in our debt instruments and other factors that our board of directors may deem relevant.
Issuer Purchases of Equity Securities
None.
Unregistered Sales of Equity Securities and Use of Proceeds
None.

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ITEM 6. SELECTED FINANCIAL DATA
Item 6. Selected Financial Data.
The consolidated statements of income information for the years ended December 31, 2021, 2020, 2019, 2018 and 2017 and the consolidated balance sheets information presented below as of December 31, 2021 and 2020 have been derived from our audited consolidated financial statements. The information presented below is only a summary and does not provide all of the information contained in our historical consolidated financial statements, including the related notes. You should read it in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our consolidated financial statements, including the related notes, included elsewhere in this Annual Report on Form 10-K. Our historical results are not necessarily indicative of the results that may be expected for any other period in the future.
Year Ended December 31,
Consolidated Statements of Income Information
(in thousands)
Interest income
$
181,968
$
167,322
$
157,531
$
124,722
$
97,830
Interest expense - portfolio related
85,386
87,826
83,903
62,597
47,638
Net interest income - portfolio related
96,582
79,496
73,628
62,125
50,192
Interest expense - corporate debt
20,609
12,049
14,618
13,322
13,654
Net interest income
75,973
67,447
59,010
48,803
36,538
Provision for (reversal of) loan losses
(292
)
5,068
1,139
Net interest income after provision for loan losses
76,265
62,379
57,871
48,602
36,117
Other operating income
Gain on disposition of loans
7,892
7,576
4,410
1,200
Unrealized gain (loss) on fair value loans
(9
)
Other income (expense)
(1,698
)
(1,752
)
1,366
Total other operating income
8,188
6,320
2,649
2,807
2,008
Operating expenses
Compensation and employee benefits
19,190
20,731
15,511
15,105
11,904
Rent and occupancy
1,769
1,743
1,531
1,320
1,115
Loan servicing
8,282
7,802
7,396
6,009
4,907
Professional fees
3,781
4,238
2,056
3,040
1,661
Real estate owned, net
3,150
2,656
2,647
1,373
Other operating expenses
8,488
8,400
5,981
5,313
3,946
Total operating expenses
44,660
45,570
35,122
32,160
24,136
Income including noncontrolling interests
39,793
23,129
25,398
19,249
13,989
Less income attributable to noncontrolling interests
-
-
-
-
-
Income attributable to Velocity Financial, Inc.
$
39,793
$
23,129
$
25,398
$
19,249
$
13,989
Income tax expense
10,569
5,352
8,106
11,618
-
Net income attributable to Velocity Financial, Inc.
$
29,224
$
17,777
$
17,292
$
7,631
$
13,989
Less undistributed earnings attributable to participating securities
8,589
-
NA
NA
NA
Less deemed dividends on preferred stock
-
48,955
NA
NA
NA
Net income (loss) allocated to common shareholders
$
20,635
$
(31,178
)
NA
NA
NA
Earnings (loss) per common share
Basic
$
0.90
$
(1.55
)
NA
NA
NA
Diluted
$
0.86
$
(1.55
)
NA
NA
NA
Weighted average common shares outstanding
Basic
22,813
20,087
NA
NA
NA
Diluted
33,982
20,087
NA
NA
NA
NA - Not applicable prior to the Company's IPO on January 17, 2020.
December 31,
Consolidated Balance Sheets Information
(in thousands)
Assets
Cash and cash equivalents
$
35,965
$
13,273
$
21,465
$
15,008
$
15,422
Restricted cash
11,639
7,020
6,087
1,669
Loans held for sale, net
87,908
13,106
214,467
78,446
5,651
Loans held for investment, net
2,527,564
1,948,089
1,863,360
1,567,408
1,299,041
Loans held for investment at fair value
1,359
1,539
2,960
3,463
4,632
Total loans, net
2,616,831
1,962,734
2,080,787
1,649,317
1,309,324
Accrued interest receivables
13,159
11,373
13,295
10,096
7,678
Receivables due from servicers
74,330
71,044
49,659
40,473
25,306
Other receivables
1,812
4,085
4,778
1,287
Real estate owned, net
17,557
15,767
13,068
7,167
5,322
Property and equipment, net
3,830
4,145
4,680
5,535
5,766
Deferred tax asset
16,604
6,654
8,280
-
Mortgage servicing rights, at fair value
7,152
-
-
-
-
Goodwill
6,775
-
-
-
-
Other assets
6,824
6,779
12,667
4,479
1,435
Total assets
$
2,812,478
$
2,102,874
$
2,214,766
$
1,735,235
$
1,371,845
Liabilities and Equity / Members' Equity
Accounts payable and accrued expenses
$
92,195
$
63,361
$
56,146
$
26,797
$
22,029
Secured financing, net
162,845
74,982
145,599
127,040
126,486
Securitizations, net
1,911,879
1,579,019
1,438,629
1,202,202
982,393
Warehouse repurchase facilities, net
301,069
75,923
421,548
215,931
85,303
Total liabilities
2,467,988
1,793,285
2,061,922
1,571,970
1,216,211
Preferred stock/Class C
preferred units
-
90,000
-
26,465
24,691
Shareholders'/Members’ equity
341,109
219,589
152,844
136,800
130,943
Noncontrolling interest in subsidiary
3,381
-
-
-
-
Total liabilities and equity / members’ equity
$
2,812,478
$
2,102,874
$
2,214,766
$
1,735,235
$
1,371,845

---

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
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 this Annual Report. This discussion contains forward-looking statements, as described above 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 Annual Report.
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 commercial properties, which we refer to collectively as investor real estate loans.
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 of December 31, 2021, has an average balance of approximately $372,000. As of December 31, 2021, our loan portfolio totaled $2.6 billion of UPB on properties in 45 states and the District of Columbia. The total portfolio had a weighted average loan-to-value ratio, or LTV at origination, of 67.7%, and was concentrated in 1-4 unit residential rental loans, which we refer to as investor 1-4 loans, representing 50.7% of the UPB. During the year ended December 31, 2021, the yield on our total portfolio was 8.56%.
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 19 securitizations, resulting in a total of over $4.0 billion in gross debt proceeds from May 2011 through December 2021.
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 year ended December 31, 2021, our portfolio related net interest margin was 4.54%. 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 ended December 31, 2021, we generated income before income taxes and net income of $39.8 million and $29.2 million, respectively, and earned a pre-tax return on equity and return on equity of 15.6% and 11.5%, respectively.
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 in January 2020, the Company operated as Velocity Financial, LLC, which was formed as a Delaware Limited Liability Company, or LLC, in 2012. Until January 1, 2018, as an LLC, we had elected to be treated as a partnership for U.S. federal and state income tax purposes, and as such, had generally not been subject to federal and state income taxes prior to January 1, 2018. Accordingly, the results of operations presented for the years prior to January 1, 2018 do not include any provision for federal or state income taxes.
Effective January 1, 2018, we elected to be treated as a corporation for U.S. federal and state income tax purposes. Accordingly, the results of operations for the year ended December 31, 2018 include the impacts of income taxes. As a result, the historical net income reported for any period prior to January 1, 2018, is not comparable to the net income reported for the year ended December 31, 2018 or subsequent 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
The 2019 Term Loan balance was $153.0 million as of December 31, 2019. During the year ended December 31, 2019, we incurred $14.6 million of interest expense related to our corporate debt. The 2019 Term Loan balance was $78.0 million as of December 31, 2020. During the year ended December 31, 2020 we incurred $12.0 million of interest expense related to our corporate debt.
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 Loan. We fully paid off the remaining $78.0 million of the 2019 Term Loan in January 2021 with a portion of the net proceeds from the 2021Term Loan. The 2021 Term Loan is a five-year $175.0 million syndicated corporate debt agreement. We incurred $20.6 million of interest expense related to our corporate debt during the year ended December 31, 2021.
Recent Developments
Acquisition of Majority Interest in Century Health & Housing Capital
On December 28, 2021, the Company acquired an 80% ownership interest in Century Health & Housing Capital, LLC (“Century”), paying a cash purchase price of $12.8 million. Founded in 1992, Century is a licensed “Ginnie Mae” issuer/servicer that provides government-insured Federal Housing Administration (FHA) mortgage financing for multifamily housing, senior housing and long-term care/assisted living facilities. Century originates loans through its borrower-direct origination channel and services the loans through its in-house servicing platform, which enables the formation of long-term relationships with its clients and drives strong portfolio retention. Century issued $158 million in UPB of loans for the year ended December 31, 2021, and manages a servicing portfolio of $521 million in UPB as of December 31, 2021. Century’s pre-tax income for the year ended December 31, 2021 was approximately $2.3 million.
Securitizations
In October and December 2021, we completed the securitizations of $204.2 million and $319.1 million, respectively, of investor real estate loans, measured by UPB. The December 2021 securitization included a portion of investor real estate loans that were previously included in our securitizations issued through Velocity Commercial Capital Loan Trust 2014-1, Velocity Commercial Capital Loan Trust 2016-2 and Velocity Commercial Capital Loan Trust 2017-1, and in connection with the December 2021 securitization those three earlier securitizations were collapsed.
At-The-Market Equity Offering Program
On September 3, 2021, we entered into separate Equity Distribution Agreements with JMP Securities LLC and Virtu 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 common shares sold under the ATM Program does not exceed 4,000,000. For the year ended December 31, 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 in the 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 Estimates Significant Accounting Policies
Our consolidated financial statements are prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States and follow general practices within the financial services industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. The most significant accounting policies we follow are summarized in “Note 2 - Basis of Presentation and Summary of Significant Accounting Policies.”
Management considers an accounting estimate to be critical to reported financial results if (1) the accounting estimates require management to make assumptions about matters that are highly uncertain, and (2) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on our consolidated financial statements, results of operations, or liquidity. Our critical accounting estimates are summarized below.
Allowance for Loan Losses
Under the current expected credit loss ("CECL") methodology, the allowance for credit losses is measured on a collective (pool) basis when similar risk characteristics exist. We identified the following portfolio segments based on risk characteristics of the loans in its loan portfolio (pool):
•Residential 1- 4 Unit - Purchase (loans to purchase 1- 4 unit residential rental properties);
•Residential 1- 4 Unit - Refinance (refinance loans on 1- 4 unit residential rental properties);
•Commercial - Purchase (loans to purchase traditional commercial properties);
•Commercial - Refinance (refinance loans on traditional commercial properties);
•Quick Fix 1- 4 Unit - Purchase (short-term loans to purchase 1- 4 unit residential rental properties); and
•Quick Fix 1- 4 Unit - Refinance (short-term refinance loans on 1- 4 unit residential rental properties).
We determined the collectability of our loans by evaluating certain risk characteristics. The segmentation of our loan portfolio was determined based on analyses of our loan portfolio performance over the past eight years. Based on analyses of the loan portfolio’s historical performance, we concluded that loan purpose and product types are the most significant risk factors in determining our expectation of future loan losses. Loan purpose considers whether a borrower is acquiring the property or refinancing an existing property. Our historical experience shows that refinance loans have higher loss rates than loans for property acquisitions. Product type includes residential 1-4 unit property and traditional commercial property. Our historical experience shows that traditional commercial property loans have higher loss rates than residential 1-4 unit property. Quick Fix loans have a maturity of one to two years from origination. Non-Quick Fix loans have a maturity of up to 30 years from origination.
We estimate the allowance for loan losses using relevant available information, from internal and external sources, relating to historical performance, current conditions, and reasonable and supportable macroeconomic forecasts. Historical credit loss experience provides the basis for the estimation of expected credit losses. Adjustments to historical loss information are considered for differences in current loan-specific risk characteristics such as differences in underwriting standards, portfolio mix, delinquency levels, or term, as well as for changes in environmental conditions, such as unemployment rates, property values and changes in the competitive or regulatory environment.
We use an open pool loss rate methodology to model expected credit losses. To determine the loss rates using the open pool method, we start with our historical database of losses, segmenting the loans by loan purpose, product type and repayment period. A third-party model applying the open pool method is used to estimate an annual average loss rate by dividing the respective pool's quarterly historical losses by the pool's respective prior quarters’ ending unamortized loan cost balance and deriving an annual average loss rate from the historical quarterly loss rates. The model then adjusts the annual average loss rates based upon macroeconomic forecasts over a reasonable and supportable period, followed by a straight-line reversion to the historical loss rates. The adjusted annual average loss rates are applied to the forecasted pool balance within each segment. The forecasted balances in the loan pool segments are calculated based on a principal amortization using contractual maturity, factoring in further principal reductions from estimated prepayments. Estimated prepayments, or Constant Prepayment Rates ("CPRs") are developed from multiple loan characteristic considerations, such as property types, FICO scores, loan purpose, and prepayment penalty terms, which is the most significant driver of prepayment activity. The prepayment penalty terms differ between the short-term and long-term loans, and we have developed a CPR curve for our short-term loans (2-year or less) and one for our long-term loans (30-year). Data from 2012-2021 is used to develop prepayment rates for our long-term loans. Because of the prepayment penalty structure in our long-term loans, prepayments during the active penalty term are historically low and begin to ramp up after the prepayment penalty term. The active prepayment penalty term is considered for existing and new loans over the reasonable and supportable forecast period in determining estimated prepayments. We back-test the CPR curves on a quarterly basis and adjust the CPR curves as appropriate. The reasonable and supportable period is meant to represent the period in which we believe the forecasted macroeconomic variables can be reasonably estimated. Significant variables or assumptions incorporated in the macroeconomic forecasts include U.S. unemployment, treasury yields, U.S. real gross domestic product (GDP), and U.S. real estate housing prices. We consider multiple scenarios from different macroeconomic forecasts and use different forecast and revision periods for estimating lifetime expected credit losses.
We have determined that once a loan becomes nonperforming (90 or more days past due), it no longer shares the same risk characteristics of the other loans within its segment of homogeneous loans (pool). We pull these loans out of the segments and evaluate the loans individually using the practical expedient to determine the credit exposure. Nonperforming loans are considered collateral dependent. Using the practical expedient, the fair value of the underlying collateral, less estimated selling costs, is compared to the carrying value of the loan in the determination of a credit loss.
The allowance for loan losses is a valuation account that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on the loans. Loans are charged off against the allowance when we believe the uncollectibility of a loan balance is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off.
The allowance for loan losses is maintained at a level deemed adequate by management to provide for expected losses in the portfolio at the balance sheet date. While we use available information to estimate our required allowance for loan losses, future additions to the allowance for loan losses may be necessary based on changes in estimates resulting from economic and other conditions.
We made the accounting policy election not to measure an allowance for loan losses for accrued interest receivables. When a loan is placed on nonaccrual status, the accrued and unpaid interest is reversed as a reduction of interest income and accrued interest receivable. Accrued interest receivable is excluded from the amortized cost of loans and it is presented as accrued interest receivable in the Consolidated Balance Sheets.
Deferred Tax Assets and Liabilities
Our deferred 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, 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 elsewhere in this Annual Report.
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 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 grew our portfolio related net interest income by $17.1 million or 21.5% from $79.5 million for the year ended December 31, 2020 to $96.6 million for the year ended December 31, 2021. The growth in net interest income is largely attributable to new 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 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.
Our five warehouse facilities and our corporate debt have interest payment obligations tied to the one-month USD London Interbank Offered Rate, or LIBOR. The authorized administrator of LIBOR confirmed during March 2021 that it intended to cease the publication or loss of representativeness of LIBOR. In particular, the last date of publication or representativeness of one-month USD LIBOR will be June 30, 2023. We expect that the index used in the calculation of the interest rate for our warehouse facilities and corporate debt will transition from LIBOR to a Secured Overnight Financing Rate or a suitable replacement index prior to June 20, 2023. We do not expect the cessation of LIBOR nor the transition to a replacement index to have a material adverse effect on our cost of funding, results of operations or financial condition.
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.
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
As of December 31,
($ in thousands)
Total loans
$
2,587,221
$
1,944,804
$
2,059,344
Loan count
6,964
5,878
6,373
Average loan balance
$
$
$
Weighted average loan-to-value
67.7
%
66.1
%
65.8
%
Weighted average coupon
7.76
%
8.51
%
8.69
%
Nonperforming loans (UPB)
$
273,100
(A)
$
332,813
$
141,607
Nonperforming loans (% of total)
10.56
%
(A)
17.11
%
6.88
%
(A) Reflects the UPB of loans 90 days or more past due or placed on nonaccrual status. Includes $53.8 million of nonaccrual loans in the Company’s COVID-19 forbearance program.
Total Loans. Total loans reflects the aggregate UPB at the end of the period. It excludes deferred origination costs, acquisition discounts, fair value adjustments and allowance for loan losses.
Loan Count. Loan count reflects the number of loans at the end of the period. It includes all loans with an outstanding principal balance.
Average Loan Balance. Average loan balance reflects the average UPB at the end of the period (i.e., total loans divided by loan count).
Weighted Average Loan-to-Value. Loan-to-value, or LTV, reflects the ratio of the original loan amount to the appraised value of the underlying property at the time of origination. In instances where the LTV at origination is not available for an acquired loan, the LTV reflects our best estimate of value at the time of acquisition. Weighted average LTV is calculated for the population of loans outstanding at the end of each specified period using the original loan amounts and appraised LTVs at the time of origination of each loan. LTV is a key statistic because requiring the borrower to invest more equity in the collateral minimizes our exposure for future credit losses.
Nonperforming Loans. Loans that are 90 or more days past due, except for certain loans in our COVID-19 forbearance program, in bankruptcy, in foreclosure, or not accruing interest are considered nonperforming loans. The dollar amount of nonperforming loans presented in the table above reflects the UPB of all loans that meet this definition.
Originations and Acquisitions
The following table presents new loan originations and acquisitions and includes average loan size, weighted average coupon and weighted average loan-to-value for the periods indicated:
($ in thousands)
Loan Count
Loan Balance
Average
Loan Size
Weighted
Average
Coupon
Weighted
Average
LTV
Year Ended December 31, 2021:
Loan originations - held for investment
3,105
$
1,326,275
$
6.9
%
69.6
%
Loan originations - held for sale
-
-
-
(-
)%
(-
)%
Total loan originations
3,105
$
1,326,275
6.9
%
69.6
%
Loan acquisitions - held for investment
11,300
7.0
%
61.4
%
Total loans originated and acquired
3,131
$
1,337,575
Year Ended December 31, 2020:
Loan originations - held for investment
$
338,815
$
8.3
%
68.0
%
Loan originations - held for sale
96,223
9.7
%
68.3
%
Total loan originations
1,271
$
435,038
8.6
%
68.1
%
Loan acquisitions - held for investment
3,467
1,156
6.5
%
73.5
%
Total loans originated and acquired
1,274
$
438,505
Year Ended December 31, 2019:
Loan originations - held for investment
1,881
$
673,877
$
8.5
%
67.1
%
Loan originations - held for sale
1,152
338,846
10.0
%
68.4
%
Total loan originations
3,033
$
1,012,723
9.0
%
67.5
%
Loan acquisitions - held for investment
9,062
7.2
%
61.9
%
Total loans originated and acquired
3,068
$
1,021,785
For the year ended December 31, 2021, we originated $1.3 billion of loans, which was an increase of $891.2 million, or 204.9% from $435.0 million for the year ended December 31, 2020. Due to the COVID-19 pandemic which adversely impacted our loan originations in 2020, we originated $435.0 million of loans in 2020, which was a decrease of $577.7 million, or 57.0% from $1.0 billion for the year ended December 31, 2019.
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 Balance Sheets 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:
December 31,
(in thousands)
Unpaid principal balance
$
2,499,798
$
1,931,875
$
1,843,290
Valuation adjustments on FVO loans
(2
)
(444
)
Deferred loan origination costs
33,360
23,600
25,714
Total loans held for investment, gross
2,533,185
1,955,473
1,868,560
Allowance for credit losses
(4,262
)
(5,845
)
(2,240
)
Loans held for investment, net
$
2,528,923
$
1,949,628
$
1,866,320
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 December 31, 2021:
December 31,
($ in thousands)
UPB
%
UPB
%
UPB
%
Loans due in less than one year
$
96,502
3.9
%
$
100,025
5.2
%
$
2,170
0.1
%
Loans due in one to five years
5,023
0.2
79,398
4.1
3,023
0.2
Loans due in more than five years
2,398,273
96.0
1,752,452
90.7
1,838,097
99.7
Total loans held for investment
$
2,499,798
100.0
%
$
1,931,875
100.0
%
$
1,843,290
100.0
%
Allowance for Loan Losses
Our allowance for loan losses decreased to $4.3 million as of December 31, 2021, from $5.8 million as of December 31, 2020. The decrease in allowance is primarily due to the broad improvement in the U.S economy in 2021 as the U.S. economy continues to recover from the adverse impacts caused by the COVID-19 pandemic.
Our allowance increased to $5.8 million as of December 31, 2020, from $2.2 million as of December 31, 2019. The increase in allowance is primarily due to the adverse business conditions caused by the COVID-19 pandemic assumed in our loan loss model projections and the one-time transfer of our held for sale loan portfolio to loans held for investment.
Our allowance for loan losses is based on an analysis of historical loan loss data from January 1, 2015 through December 31, 2021, adjusted for macroeconomic forecasts. We strive to minimize actual credit losses through our rigorous screening and underwriting process, life of loan portfolio management and special servicing practices. Additionally, we believe borrower equity of 25% to 40% provides significant protection against credit losses should a loan become impaired.
To estimate the allowance for loan losses in our loans held for investment portfolio, we follow a detailed internal process, considering a number of different factors including, but not limited to, our ongoing analyses of loans, historical loss rates, relevant environmental factors, relevant market research, trends in delinquencies, effects and changes in credit concentrations, and ongoing evaluation of fair values.
The following table illustrates the activity in our allowance for loan losses over the periods indicated:
December 31,
($ in thousands)
Allowance for credit losses:
Beginning balance
$
5,845
$
2,240
$
1,680
Impact of adopting ASC 326
-
-
Provision for loan losses
(292
)
5,068
(1)
1,139
Charge-offs
(1,291
)
(1,600
)
(579
)
Ending balance
$
4,262
$
5,845
$
2,240
Total loans held for investment (UPB), excluding FVO
$
2,498,466
$
1,930,334
(2)
$
1,839,886
Allowance for credit losses / loans held for investment, excluding FVO
0.17
%
0.30
%
0.12
%
(1)The provision for loans losses would have been approximately $3.9 million for the year ended December 31, 2020, excluding the $1.2 million impact from the loans held for sale transferred to loans held for investment. The additional $1.2 million provision was mainly offset by the reversal of the $1.3 million valuation allowance on the held for sale loans, which was recorded to “Other income” in the consolidated statements of income.
(2)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 $5.8 million, and net deferred loan origination fees/costs of $23.6 million as of December 31, 2020.
Credit Quality - Loans Held for Investment
The following table provides delinquency information, by unpaid principal balance, on our held for investment loan portfolio as of the dates indicated:
December 31, 2021 (A)
COVID-19
Forbearance
December 31, 2020 (A)
COVID-19
Forbearance
December 31, 2019 (B)
Performing/Accruing:
Current
$
2,068,023
82.7
%
$
188,466
$
1,445,131
74.9
%
$
259,147
$
1,559,373
84.6
%
30-59 days past due
127,046
5.1
36,579
89,284
4.6
32,115
123,704
6.7
60-89 days past due
31,629
1.3
8,262
62,694
3.2
34,493
48,062
2.6
90+ days past due
-
-
-
1,953
0.1
1,953
-
-
Total performing loans
2,226,698
89.1
233,307
1,599,062
82.8
327,708
1,731,139
93.2
Nonperforming/Nonaccrual:
<90 days past due
19,533
0.8
5,325
20,778
1.1
-
-
90+ days past due
35,787
1.4
8,510
82,004
4.2
34,120
24,790
1.3
Bankruptcy
20,038
0.8
6,242
12,655
0.7
1,650
8,695
0.5
In foreclosure
197,742
7.9
39,045
217,376
11.2
27,868
78,666
4.3
Total nonperforming
loans
273,100
10.9
59,122
332,813
17.2
64,365
112,151
6.1
Total loans held for
investment
$
2,499,798
100.0
%
$
292,429
$
1,931,875
100.0
%
$
392,073
$
1,843,290
100.0
%
(A)Balance includes $292.4 million UPB of loans held for investment as of December 31, 2021 and $392.1 million as of December 31, 2020 in our COVID-19 forbearance program.
(B)Prior to January 1, 2020, nonperforming loans included loans that were 90 or more days past due, in bankruptcy, or in foreclosure.
Other than loans while they were 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 $273.1 million, or 10.9% of our held for investment loan portfolio as of December 31, 2021, compared to $332.8 million, or 17.2% as of December 31, 2020, and $112.2 million, or 6.1% of the loan portfolio as of December 31, 2019. The decrease in total nonperforming loans as of December 31, 2021 compared to December 31, 2020 was primarily attributable to loan resolutions by our Special Servicing department, along with improvement in the U.S. economy. The increase in total nonperforming loans as of December 31, 2020 compared to December 31, 2019 was primarily attributable to the COVID-19 pandemic.
Resolutions of non-performing loans
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 resolution activities of loans that were nonperforming or became nonperforming during the periods indicated. We resolved $108.4 million, $83.4 million, and $73.4 million of long-term nonperforming loans during the years ended December 31, 2021, December 31, 2020, and December 31, 2019, respectively. Including REO resolutions, we realized net gains of $5.0 million, $2.7 million, and $1.8 million during the years ended December 31, 2021, December 31, 2020, and December 31, 2019, respectively. This is largely the result of collecting default interest and prepayment penalties in excess of the contractual interest due and collected.
The table below includes nonperforming loan resolutions for our long-term loans.
Long-Term Loans
December 31, 2021
December 31, 2020
December 31, 2019
($ in thousands)
UPB
Gain /
(Loss)
UPB
Gain /
(Loss)
UPB
Gain /
(Loss)
Resolved - paid in full
$
62,703
$
4,106
$
45,662
$
2,029
$
37,211
$
1,197
Resolved - paid current
45,654
37,705
1,213
36,169
Resolved - REO sold (1)
10,151
4,362
(498
)
4,077
(68
)
Total resolutions
$
118,508
$
4,982
$
87,729
$
2,744
$
77,457
$
1,846
Recovery rate on resolved
nonperforming UPB
104.2
%
103.1
%
102.4
%
(1)There was an REO property held since January 2019 that was sold during the quarter ended September 30, 2021, with a total lifetime loss of $1.7 million, all of which was recognized in prior periods.
The table below includes nonperforming loan resolutions for our short-term loans, now being held for investment, and also includes loans that were granted a COVID-19 forbearance in 2020. Prior to January 1, 2020, nonperforming loan resolutions presented only consisted of long-term nonperforming loans held for investment since the short-term loans, or loans with a maturity of two-year or less, were being held for sale until later in 2020. The short-term loans do not require prepayment fees and usually result in a lower gain when paid in full, as compared to long term loans.
Short-Term Loans
December 31, 2021
December 31, 2020
December 31, 2019
($ in thousands)
UPB
Gain /
(Loss)
UPB
Gain /
(Loss)
UPB
Gain /
(Loss)
Resolved - paid in full
$
43,613
$
2,312
$
-
$
-
$
-
$
-
Resolved - paid current
49,942
-
-
-
-
Resolved - REO sold
-
-
-
-
Total resolutions
$
94,089
$
2,529
$
-
$
-
$
-
$
-
Recovery rate on resolved
nonperforming UPB
102.7
%
N/A
N/A
Total long-term and short-term nonperforming loan resolutions were $42.1 million, $29.8 million, and $13.0 million during the quarters ended December 31, 2021, 2020 and 2019, respectively.
Charge-offs
Our actual losses incurred have been small as a percentage of nonperforming loans held for investment. The table below shows our actual loan losses for the periods indicated.
Year Ended December 31,
($ in thousands)
Average nonperforming loans for the period (1)
$
307,562
$
246,972
$
102,567
Charge-offs
$
1,291
$
1,600
$
Charge-offs / Average nonperforming loans for the period (1)
0.42
%
0.65
%
0.56
%
(1)Reflects the monthly average of nonperforming loans held for investment during the period.
Concentrations - Loans Held for Investment
As of December 31, 2021, our held for investment loan portfolio was concentrated in investor 1-4 loans, representing 49.0% of the UPB and mixed use properties represented 13.2% 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 23.4% in California, 21.6% in New York, 13.4% in Florida, and 7.9% in New Jersey.
Property Type
December 31, 2021
($ in thousands)
Loan Count
UPB
% of Total
UPB
Investor 1-4
3,901
$
1,224,672
49.0
%
Mixed use
330,654
13.2
Multifamily
227,883
9.1
Retail
234,470
9.4
Office
158,706
6.3
Warehouse
172,653
6.9
Other(1)
150,760
6.0
Total loans held for investment
6,769
$
2,499,798
%
(1)All other properties individually comprise less than 5.0% of the total unpaid principal balance.
Geography (State)
December 31, 2021
($ in thousands)
Loan Count
UPB
% of Total
UPB
California
$
584,832
23.4
%
New York
539,430
21.6
Florida
335,143
13.4
New Jersey
196,482
7.9
Other(1)
3,022
843,911
33.8
Total loans held for investment
6,769
$
2,499,798
%
(1)All other states individually comprise less than 5.0% of the total unpaid principal balance.
Loans Held for Sale
The following tables show the various components of loans held for sale as of the dates indicated:
December 31,
($ in thousands)
UPB
$
87,422
$
12,929
$
216,054
Valuation adjustments
-
(17
)
(396
)
Deferred loan origination fees, net
(1,191
)
Total loans held for sale, net
$
87,908
$
13,106
$
214,467
Concentrations - Loans Held for Sale
As of December 31, 2021, our held for sale loan portfolio was all investor 1-4 loans, which represented 100.0% of the UPB. By geography, the principal balance of our loans held for investment were concentrated 21.8% in California, 16.5% in New York, 15.1% in Florida, 5.9% in Pennsylvania, and 6.5% in Texas.
Geography (State)
December 31, 2021
($ in thousands)
Loan Count
UPB
% of Total
UPB
California
$
19,097
21.8
%
New York
14,383
16.5
Florida
13,214
15.1
Pennsylvania
5,197
5.9
Texas
5,654
6.5
Other(1)
29,877
34.2
Total loans held for sale
$
87,422
%
(1)All other states individually comprise less than 5.0% of the total unpaid principal balance.
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 of December 31, 2021, our REO included 34 properties with a carrying value of $17.6 million compared to 35 properties with a carrying value of $15.8 million as of December 31, 2020.
Key Performance Metrics
Year Ended December 31,
($ in thousands)
Average loans
$
2,125,847
$
2,043,665
$
1,782,558
Portfolio yield
8.56
%
8.19
%
8.84
%
Average debt - portfolio related
1,814,048
1,803,188
1,603,459
Average debt - total company
1,968,938
1,885,306
1,745,728
Cost of funds - portfolio related
4.71
%
4.87
%
5.23
%
Cost of funds - total company
5.38
%
5.30
%
5.64
%
Net interest margin - portfolio related
4.54
%
3.89
%
4.13
%
Net interest margin - total company
3.57
%
3.30
%
3.31
%
Charge-offs
0.06
%
0.08
%
0.03
%
Pre-tax return on equity
15.58
%
10.69
%
17.37
%
Return on equity
11.45
%
8.22
%
11.78
%
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 and Total Company
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 and Total Company
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 decreased to 4.71% for the year ended December 31, 2021 from 4.87% and 5.23% for the years ended December 31, 2020 and 2019, respectively. The decrease in portfolio related cost of funds was primarily attributable to improved execution on the securitizations.
Net Interest Margin - Portfolio Related and Total Company
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.
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,
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
$
15,794
$
110,810
$
106,852
Loans held for investment
2,110,053
1,932,855
1,675,706
Total loans
$
2,125,847
$
181,968
8.56
%
$
2,043,665
$
167,322
8.19
%
$
1,782,558
$
157,531
8.84
%
Debt:
Warehouse and repurchase facilities
$
183,663
9,706
5.28
%
$
168,099
8,352
4.97
%
$
240,608
13,583
5.65
%
Securitizations
1,630,385
75,680
4.64
%
1,635,089
79,474
4.86
%
1,362,851
70,320
5.16
%
Total debt - portfolio related
1,814,048
85,386
4.71
%
1,803,188
87,826
4.87
%
1,603,459
83,903
5.23
%
Corporate debt
154,890
20,609
13.31
%
(4)
82,117
12,049
14.67
%
(3)
142,269
14,617
10.27
%
Total debt
$
1,968,938
$
105,995
5.38
%
$
1,885,305
$
99,875
5.30
%
$
1,745,728
$
98,520
5.64
%
Net interest spread -
portfolio related (1)
3.85
%
3.32
%
3.60
%
Net interest margin -
portfolio related
4.54
%
3.89
%
4.13
%
Net interest spread -
total company (2)
3.18
%
(4)
2.89
%
(3)
3.19
%
Net interest margin -
total company
3.57
%
(4)
3.30
%
(3)
3.31
%
(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.
(3)Excluding the one-time debt issuance costs write-off of $3.5 million and prepayment penalties of $0.3 million associated with the $75.0 million repayment of our corporate debt in January 2020, the Corporate debt average rate would have been 10.08%; Net interest spread - total company would have been 3.09%; and Net interest margin - total company would have been 3.48% for the year ended December 31, 2020.
(4)Excluding the one-time debt issuance costs write-off of $2.9 million related to our corporate debt refinancing in February 2021, the Corporate debt average yield would have been 11.40%; Net interest spread - total company would have been 3.33%; and Net interest margin - total company would have been 3.71% for the year ended December 31, 2021.
Charge-Offs
The charge-offs ratio reflects charge-offs as a percentage of average loans held for investment over the specific time period. We do not record charge-offs on our loans held for sale which are carried at the lower of cost or estimated fair value.
Pre-Tax Return on Equity and Return on Equity
Pre-tax return on equity and return on equity reflect income before income taxes and net income, respectively, as a percentage of the monthly average of members’ equity over the specified time period.
Year Ended December 31,
($ in thousands)
Income before income taxes (A)
$
39,793
$
23,129
$
25,398
Net income (B)
29,224
17,777
17,292
Monthly average balance:
Stockholders' / Members' equity (C)
255,331
216,289
146,236
Pre-tax return on equity (A)/(C)
15.6
%
10.7
%
17.4
%
Return on equity (B)/(C)
11.4
%
8.2
%
11.8
%
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
In February 2021, we entered into a five-year $175.0 million syndicated corporate debt agreement (“2021 Term Loan”). The 2021 Term Loan bears interest at a rate equal to one-month LIBOR plus 8.00%, with a 1.00% LIBOR floor, and matures in February 2026. A portion of the net proceeds from the 2021 Term Loan was used to redeem all the outstanding corporate debt on our 2019 Term Loan.
Interest expense on corporate debt primarily consists of interest expense paid 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
Effective January 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.
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 to the recognition 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 Annual Report. Changes in fair value are reported as a component of other operating income within our consolidated statements of income.
Other Income. Other income includes the following:
Unrealized Gains/(Losses) on Retained 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.
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 deferred U.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 pretax income with various permanent differences. The tax-adjusted income amount is then multiplied by the applicable federal and state income tax rates to arrive at the provision for income taxes. Prior to January 1, 2018, we had elected to be treated as a partnership for U.S. federal income tax purposes and were, therefore, not required to pay income taxes because of our treatment as a pass-through entity. Effective January 1, 2018, we changed our election to be taxed as a corporation for U.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:
Year Ended December 31,
($ in thousands)
Interest income
$
181,968
$
167,322
$
157,531
Interest expense - portfolio related
85,386
87,826
83,903
Net interest income - portfolio related
96,582
79,496
73,628
Interest expense - corporate debt
20,609
12,049
14,618
Net interest income
75,973
67,447
59,010
Provision for (reversal of) loan losses
(292
)
5,068
1,139
Net interest income after provision for loan
losses
76,265
62,379
57,871
Other operating income
8,188
6,320
2,649
Total operating expenses
44,660
45,570
35,122
Income including noncontrolling interests
39,793
23,129
25,398
Less net income attributable to noncontrolling interests
-
-
-
Income attributable to Velocity Financial, Inc.
39,793
23,129
25,398
Income tax expense
10,569
5,352
8,106
Net income attributable to Velocity Financial, Inc.
$
29,224
$
17,777
$
17,292
Less undistributed earnings attributable to participating securities (1)
8,589
-
NA
Less deemed dividends on preferred stock (1)
-
48,955
NA
Net income (loss) allocated to common shareholders
$
20,635
$
(31,178
)
NA
Earnings (loss) per common share (1)
Basic
$
0.90
$
(1.55
)
NA
Diluted
$
0.86
$
(1.55
)
NA
Weighted average common shares outstanding (1)
Basic
22,813
20,087
NA
Diluted
33,982
20,087
NA
(1)Not applicable prior to the Company's IPO on January 17, 2020.
Year Ended December 31, 2021 Compared to Year Ended December 31, 2020
Net Interest Income - Portfolio Related
Year Ended December 31,
($ in thousands)
$ Change
% Change
Interest income
$
181,968
$
167,322
$
14,646
8.8
%
Interest expense - portfolio related
85,386
87,826
(2,440
)
(2.8
)%
Net interest income - portfolio related
$
96,582
$
79,496
$
17,086
21.5
%
Interest Income. Interest income increased by $14.6 million, or 8.8%, to $182.0 million during the year ended December 31, 2021, compared to $167.3 million during the year ended December 31, 2020. The increase is primarily attributable to the increase in average yield and an increase in average loans (volume). The average yield increased to 8.56% from 8.19%. Average loans increased $82.2 million, or 4.0%, from $2.0 billion for the year ended December 31, 2020 to $2.1 billion for the year ended December 31, 2021. The increase in average yield is primarily attributable to the recognition of default interest and prepayment fees for resolutions of nonperforming loans.
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 average loan balance (i.e., $82.2 million) by the previous period’s average yield (i.e., 8.19%). Similarly, the effect of rate changes is calculated by multiplying the change in average yield (i.e., 0.37%) by the current period’s average loan balance (i.e., $2.1 billion).
Year Ended December 31, 2021 and 2020
($ in thousands)
Average
Loans
Interest
Income
Average
Yield
Year Ended December 31, 2021
$
2,125,847
$
181,968
8.56
%
Year Ended December 31, 2020
2,043,665
167,322
8.19
%
Volume variance
82,182
6,729
Rate variance
7,917
0.37
%
Total interest income variance
$
14,646
Interest Expense - Portfolio Related. Portfolio related interest expense consists of interest incurred on our warehouse facilities and securitizations, which decreased by $2.4 million, or 2.8%, to $85.4 million for the year ended December 31, 2021, from $87.8 million for the year ended December 31, 2020. The decrease in portfolio related interest expense in 2021 was primarily attributable to the lower cost of funds, which decreased to 4.71% for the year ended December 31, 2021 from 4.87% for the year ended December 31, 2020. The decrease in cost of funds was partially offset by the increase in average debt balance. The lower cost of funds was mainly attributable to improved securitization spreads.
The following table presents information regarding the decrease in portfolio related interest expense and distinguishes between the dollar amount of change in interest expense attributable to changes in the average outstanding debt balance (volume) versus changes in cost of funds (rate) for the years ended December 31, 2021 and 2020.
Year Ended December 31, 2021 and 2020
($ in thousands)
Average
Debt (1)
Interest
Expense
Cost of
Funds
Year Ended December 31, 2021
$
1,814,048
$
85,386
4.71
%
Year Ended December 31, 2020
1,803,188
87,826
4.87
%
Volume variance
10,860
Rate variance
(2,969
)
(0.16
)%
Total interest expense variance
$
(2,440
)
(1) Includes securitizations and warehouse repurchase agreements.
Net Interest Income After Provision for Loan Losses
Net interest income after provision for loan losses increased 22.3% over the prior year driven by higher net interest income and a reversal of prior year provision expense.
Year Ended December 31,
($ in thousands)
$ Change
% Change
Net interest income - portfolio related
$
96,582
$
79,496
$
17,086
21.5
%
Interest expense - corporate debt
20,609
12,049
8,560
71.0
%
Net interest income
75,973
67,447
8,526
12.6
%
Provision for (reversal of) loan losses
(292
)
5,068
(5,360
)
(105.8
)
%
Net interest income after provision
for loan losses
$
76,265
$
62,379
$
13,886
22.3
%
Interest Expense - Corporate Debt. Corporate debt interest expense increased by $8.6 million from $12.0 million for the year ended December 31, 2020 to $20.6 million for the year ended December 31, 2021 primarily due to the increase in corporate debt balance. The corporate debt balance was $170.8 million as of December 31, 2021 compared to $78.0 million as of December 31, 2020, as a result of 2021 Term Loan agreement we entered into in February 2021.
Provision for (reversal of) Loan Losses. Our provision for loan losses decreased by approximately $5.4 million from the provision of $5.1 million for the year ended December 31, 2020 to a reversal of $0.3 million for the year ended December 31, 2021. The decrease in provision for loan losses is primarily attributable to the improvement in the U.S economy as the U.S economy continues to recover from the negative impacts caused by the COVID-19 pandemic in 2020.
Other Operating Income
The table below presents the various components of other operating income for the year ended December 31, 2021 compared to the year ended December 31, 2020. The $1.9 million net increase is primarily due to the unrealized loss in 2020 related to interest-only securities that matured in 2020. The unrealized loss on interest-only securities is included in other income (expense).
Year Ended December 31,
($ in thousands)
$ Change
% Change
Gain on disposition of loans
$
7,892
$
7,576
$
4.2
%
Unrealized gain (loss) on fair value loans
(413
)
(93.4
)%
Other income (expense)
(1,698
)
1,965
(115.7
)%
Total other operating income
$
8,188
$
6,320
$
1,868
29.6
%
Operating Expenses
Total operating expenses decreased by 2.0%, or $0.9 million to $44.7 million during the year ended December 31, 2021 from $45.6 million during the year ended December 31, 2020. This decrease is primarily attributable to a higher percentage of direct loan origination costs included in the compensation and employee benefits and other operating expenses in 2020 due to the suspension of loan production from mid-March through August.
Year Ended December 31,
($ in thousands)
$ Change
% Change
Compensation and employee benefits
$
19,190
$
20,731
$
(1,541
)
(7.4
)%
Rent and occupancy
1,769
1,743
1.5
%
Loan servicing
8,282
7,802
6.2
%
Professional fees
3,781
4,238
(457
)
(10.8
)%
Real estate owned, net
3,150
2,656
18.6
%
Other operating expenses
8,488
8,400
1.0
%
Total operating expenses
$
44,660
$
45,570
$
(910
)
(2.0
)%
Compensation and Employee Benefits. Compensation and employee benefits decreased from $20.7 million during the year ended December 31, 2020 to $19.2 million during year ended December 31, 2021. During April through August of 2020, when loan originations were suspended and staff was working on offering existing borrowers the COVID-19 forbearance program, compensation costs for the employees were expensed when, under normal operating conditions, the same compensation costs would be deferred over new loan production.
Rent and Occupancy. Rent and occupancy expenses remained relatively consistent at approximately $1.8 million during the years ended December 31, 2021 and 2020 due to no change in office space.
Loan Servicing. Loan servicing expenses increased from $7.8 million during the year ended December 31, 2020 to $8.3 million during the year ended December 31, 2021. The $0.5 million increase during the year ended December 31, 2021 is mainly due to the increase in our loan portfolio.
Professional Fees. Professional fees decreased from $4.2 million for the year ended December 31, 2020 to $3.8 million for the year ended December 31, 2021, mainly due to the decrease in legal fees related to the IPO class action lawsuit which was dismissed in January 2021.
Net Expenses of Real Estate Owned. Net expenses of real estate owned increased from $2.7 million during the year ended December 31, 2020 to $3.2 million during the year ended December 31, 2021. The $0.5 million increase is mainly due to a smaller gain on disposition and the increase in taxes and insurance for the properties.
Other Operating Expenses. Other operating expenses slightly increased from $8.4 million for the year ended December 31, 2020 to $8.5 million for the year ended December 31, 2021, mainly due to the increase in appraisal fee expenses.
Income Tax Expense. Income tax expense was $10.6 million for the year ended December 31, 2021, compared to $5.4 million for the year ended December 31, 2020. Our consolidated effective tax rate as a percentage of pre-tax income for 2021 was 26.6%, compared to 23.1% for 2020. The 2021 effective tax rate differed from the federal statutory rate of 21% principally because of state taxes.
Year Ended December 31, 2020 Compared to Year Ended December 31, 2019
Net Interest Income - Portfolio Related
Year Ended December 31,
($ in thousands)
$ Change
% Change
Interest income
$
167,322
$
157,531
$
9,791
6.2
%
Interest expense - portfolio related
87,826
83,903
3,923
4.7
%
Net interest income - portfolio related
$
79,496
$
73,628
$
5,868
8.0
%
Interest Income. Interest income increased by $9.8 million, or 6.2%, to $167.3 million during the year ended December 31, 2020, compared to $157.5 million during the year ended December 31, 2019. The increase is primarily attributable to an increase in average loans (volume), which increased $261.1 million, or 14.6%, from $1.8 billion for the year ended December 31, 2019 to $2.0 billion for the year ended December 31, 2020. The average yield over those same periods decreased from 8.84% to 8.19% mainly due to the increase in nonperforming loans due to the COVID-19 pandemic.
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 average loan balance (i.e., $261.1 million) by the previous period’s average yield (i.e., 8.84%). Similarly, the effect of rate changes is calculated by multiplying the change in average yield (i.e., 0.65%) by the current period’s average loan balance (i.e., $2.0 billion).
Year Ended December 31, 2020 and 2019
($ in thousands)
Average
Loans
Interest
Income
Average
Yield
Year Ended December 31, 2020
$
2,043,665
$
167,322
8.19
%
Year Ended December 31, 2019
1,782,558
157,531
8.84
%
Volume variance
261,107
23,075
Rate variance
(13,284
)
(0.65
)%
Total interest income variance
$
9,791
Interest Expense - Portfolio Related. Portfolio related interest expense consists of interest incurred on our warehouse facilities and securitizations, which increased by $3.9 million, or 4.7% to $87.8 million for the year ended December 31, 2020, from $83.9 million for the year ended December 31, 2019. The increase in portfolio related interest expense in 2020 was primarily attributable to the increased average balance, partially offset by a lower cost of funds, which decreased to 4.87% for the year ended December 31, 2020 from 5.23% for the year ended December 31, 2019, and was mainly attributable to improved securitization spreads.
The following table presents information regarding the increase in portfolio related interest expense and distinguishes between the dollar amount of change in interest expense attributable to changes in the average outstanding debt balance (volume) versus changes in cost of funds (rate) for the years ended December 31, 2020 and 2019.
Year Ended December 31, 2020 and 2019
($ in thousands)
Average
Debt (1)
Interest
Expense
Cost of
Funds
Year Ended December 31, 2020
$
1,803,188
$
87,826
4.87
%
Year Ended December 31, 2019
1,603,459
83,903
5.23
%
Volume variance
199,729
10,451
Rate variance
(6,528
)
(0.36
)%
Total interest expense variance
$
3,923
(1) Includes securitizations and warehouse repurchase agreements.
Net Interest Income After Provision for Loan Losses
Year Ended December 31,
($ in thousands)
$ Change
% Change
Net interest income - portfolio related
$
79,496
$
73,628
$
5,868
8.0
%
Interest expense - corporate debt
12,049
14,618
(2,569
)
(17.6
)
%
Net interest income
67,447
59,010
8,437
14.3
%
Provision for loan losses
5,068
1,139
3,929
345.0
%
Net interest income after provision
for loan losses
$
62,379
$
57,871
$
4,508
7.8
%
Interest Expense - Corporate Debt. Corporate debt interest expense decreased by $2.6 million from $14.6 million for the year ended December 31, 2019 to $12.0 million for the year ended December 31, 2020 primarily due to the decrease in the corporate debt balance. The corporate debt balance was $78.0 million as of December 31, 2020 compared to $153.0 million as of December 31, 2019, as a result of a $75.0 million debt paydown in January 2020 using a portion of our IPO proceeds.
Provision for Loan Losses. Our provision for loan losses increased $3.9 million from $1.1 million during the year ended December 31, 2019 to $5.1 million during the year ended December 31, 2020, primarily attributable to the adverse business conditions caused by the COVID-19 pandemic assumed in our loan loss model projections and the $1.2 million increase due to the one-time transfer of our held for sale loan portfolio.
Other Operating Income
The table below presents the various components of other operating income for the year ended December 31, 2020 compared to the year ended December 31, 2019. The $3.7 million increase is primarily due to the increase in gain on disposition of loans.
Year Ended December 31,
($ in thousands)
$ Change
% Change
Gain on disposition of loans
$
7,576
$
4,410
$
3,166
71.8
%
Unrealized gain (loss) on fair value loans
(9
)
(5011.1
)%
Other expense
(1,698
)
(1,752
)
(3.1
)%
Total other operating income
$
6,320
$
2,649
$
3,671
138.6
%
Operating Expenses
Total operating expenses increased $10.4 million, or 29.7%, to $45.6 million during the year ended December 31, 2020 from $35.1 million during the year ended December 31, 2019. This increase is primarily attributable to direct loan origination costs included in the Compensation and employee benefits and Other operating expenses that were expensed in 2020 due to the suspension of loan production from mid-March through August.
Year Ended December 31,
($ in thousands)
$ Change
% Change
Compensation and employee benefits
$
20,731
$
15,511
$
5,220
33.7
%
Rent and occupancy
1,743
1,531
13.8
%
Loan servicing
7,802
7,396
5.5
%
Professional fees
4,238
2,056
2,182
106.1
%
Real estate owned, net
2,656
2,647
0.3
%
Other operating expenses
8,400
5,981
2,419
40.4
%
Total operating expenses
$
45,570
$
35,122
$
10,448
29.7
%
Compensation and Employee Benefits. Compensation and employee benefits increased from $15.5 million during the year ended December 31, 2019 to $20.7 million during the year ended December 31, 2020. During April through August, when loan originations were suspended and staff was working on offering existing borrowers the COVID-19 forbearance program, compensation costs for the employees were expensed when, under normal operating conditions, the same compensation costs would be deferred over new loan production. In addition, we expensed a one-time severance payment of $0.6 million in September 2020 as a result of the staff reduction caused by the COVID-19 pandemic.
Rent and Occupancy. Rent and occupancy expenses increased from $1.5 million during the year ended December 31, 2019 to $1.7 million during the year ended December 31, 2020 due to the increase in office space.
Loan Servicing. Loan servicing expenses increased from $7.4 million during the year ended December 31, 2019 to $7.8 million during the year ended December 31, 2020. The $0.4 million increase during the year 2020 was primarily related to the increase in our loan portfolio.
Professional Fees. Professional fees increased from $2.1 million for the year ended December 31, 2019 to $4.2 million for the year ended December 31, 2020 mainly due to our growth and increased costs as a public company.
Net Expenses of Real Estate Owned. Net expenses of real estate owned remained fairly constant from $2.6 million during the year ended December 31, 2019 to $2.7 million during the year ended December 31, 2020, and were mainly comprised of valuation adjustment expense.
Other Operating Expenses. Other operating expenses increased from $6.0 million for the year ended December 31, 2019 to $8.4 million for the year ended December 31, 2020 mainly due to increased costs of being a public company, such as insurance, directors’ expense, and SEC filing fees.
Income Tax Expense. Income tax expense was $5.4 million for the year ended December 31, 2020, compared to $8.1 million for the year ended December 31, 2019. Our consolidated effective tax rate as a percentage of pre-tax income for 2020 was 23.1%, compared to 31.9% for 2019. The 2020 effective tax rate differed from the federal statutory rate of 21.0% principally because of state taxes. The reduction in the 2020 consolidated effective tax rate, compared to the 2019 rate, was mainly due to a change in unrecognized tax benefits in 2019.
Quarterly Results of Operations
The following table sets forth certain financial information for each completed fiscal quarter since the quarter ended March 31, 2020. The quarterly information has been prepared on the same basis as the consolidated financial statements and includes all adjustments (consisting of normal recurring adjustments) that, in the opinion of management, are necessary for a fair presentation of the information presented. This information should be read in conjunction with the consolidated financial statements and related notes thereto included elsewhere in this Annual Report. Operating results for interim periods are not necessarily indicative of the results that may be expected for a full fiscal year.
The following tables set for our unaudited quarterly results for the periods indicated:
Three Months Ended
December 31,
September 30,
June 30,
March 31,
December 31,
September 30,
June 30,
March 31,
(in thousands)
(unaudited)
Interest income
$
49,360
$
46,923
$
44,978
$
40,707
$
41,556
$
41,374
$
39,755
$
44,637
Interest expense - portfolio related
23,666
20,321
20,566
20,832
21,442
22,347
21,189
22,848
Net interest income - portfolio related
25,694
26,602
24,412
19,875
20,114
19,027
18,566
21,789
Net interest margin - portfolio related
4.27
%
4.97
%
4.83
%
4.10
%
4.07
%
3.77
%
3.54
%
4.18
%
Interest expense - corporate debt
4,462
4,488
4,309
7,350
1,900
1,913
1,894
6,342
Net interest income
21,232
22,114
20,103
12,525
18,214
17,114
16,672
15,447
Net interest margin - total company
3.53
%
4.13
%
3.98
%
2.59
%
3.68
%
3.39
%
3.18
%
2.97
%
Provision for (reversal of) loan losses
(1,000
)
1,573
1,800
1,290
Net interest income after provision
for loan losses
20,855
21,886
21,103
12,420
17,808
15,541
14,872
14,157
Other operating income (expense)
2,617
2,432
2,801
4,691
1,349
(1,339
)
1,620
Operating expenses
12,095
11,298
10,650
10,617
10,746
11,865
10,908
12,050
Income before income taxes
11,377
10,927
12,885
4,604
11,753
5,025
2,625
3,727
Income tax expense
3,024
2,905
3,432
1,208
2,177
1,544
1,148
Net income
$
8,353
$
8,022
$
9,453
$
3,396
$
9,576
$
3,481
$
2,141
$
2,579
Liquidity and Capital Resources
Sources and Uses of Liquidity
We fund our lending activities primarily through borrowings under our warehouse repurchase facilities, securitizations, 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.
Cash and Cash Equivalents
As of December 31, 2021, we had liquidity of approximately $47.0 million in cash and cash equivalents comprised of approximately $36.0 million of unrestricted cash and $11.0 million of available liquidity on unfinanced loans. As of December 31, 2021, we had $349.9 million of available capacity under our warehouse and repurchase facilities.
As of December 31, 2020, we had liquidity of approximately $14.5 million in cash and eligible collateral borrowings under our warehouse facilities. Cash comprised $13.3 million of our liquidity and eligible collateral borrowings under our warehouse facilities comprised $1.2 million of our liquidity. As of December 31, 2020, we had $76.5 million of uncommitted available capacity under our warehouse facilities.
During the year ended December 31, 2021, we generated approximately $27.3 million of net cash and cash equivalents from operations, investing and financing activities. During the year ended December 31, 2020, we used approximately $7.3 million of net cash and cash equivalents from operations, investing and financing activities.
Warehouse Facilities
As of December 31, 2021, we had four non-mark-to-market warehouse facilities and one modified mark-to-market warehouse facility to support our loan origination and acquisition facilities. One agreement is a two-year warehouse repurchase facility, two agreements are one-year warehouse repurchase facilities and two agreements are three-year warehouse facilities. The borrowings are collateralized by primarily performing loans, bearing interest at one-month LIBOR with a 0.75% floor plus a margin that ranges from 2.75% to 4.50%. Borrowing under these facilities was $300.1 million with $349.9 million of available capacity under our warehouse and repurchase facilities as of December 31, 2021.
As of December 31, 2020, we had two warehouse facilities to support our loan origination and acquisition activities. One agreement is a one-year warehouse repurchase facility and the other agreement is a three-year warehouse facility. Under both agreements, the borrowings are collateralized by pools of primarily performing loans, bearing interest at one-month LIBOR with a 0.75% LIBOR floor plus a margin that ranges from 2.75% to 3.50%. As of December 31, 2020, these two agreements had an aggregated maximum borrowing capacity of $150.0 million. Borrowings under these facilities as of December 31, 2020 were $73.5 million. We added a third $200 million committed, non-mark-to-market warehouse facility in January 2021.
All warehouse 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 facilities 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 facilities, which then allows us to draw additional funds on a revolving basis under the facilities. The revolving warehouse facilities also contain customary covenants, including but not limited to 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 of December 31, 2021, we were in compliance with these covenants.
Securitizations
From May 2011 through December 2021, we have completed 19 securitizations of $4.4 billion of investor real estate loans, issuing $4.0 billion in principal amount of securities to third parties through fifteen respective transactions. 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 under U.S. GAAP. Tables summarizing the investor real estate loans securitized, securities issued, securities retained by the Company at the time of the securitization, and as of December 31, 2021 and 2020, the stated maturity for each securitization, the outstanding bond balances, and the weighted average rate on the securities for the Trusts as of December 31, 2021 and 2020, 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. 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)
Cash provided by (used in):
Operating activities
$
57,622
$
54,892
$
(105,336
)
Investing activities
(656,483
)
87,739
(305,934
)
Financing activities
626,172
(149,890
)
422,145
Net change in cash, cash equivalents, and restricted
cash
$
27,311
$
(7,259
)
$
10,875
Operating Activities
Cash flows from operating activities primarily includes net income adjusted for (1) non-cash items including depreciation, provision for loan loss, discount accretion, and valuation changes, (2) changes in the balances of operating assets and liabilities, (3) gain on disposition of loans.
For the year ended December 31, 2021, our net cash provided by operating activities of $57.6 million consisted mainly of $29.2 million in net income, and $20.2 million add-back of noncash debt issuance discounts and costs amortization.
For the year ended December 31, 2020, our net cash provided by operating activities of $54.9 million consisted mainly of $96.1 million cash used to originate held for sale loans, offset by $79.6 million proceeds, net of repurchases, from sale of loans held for sale, $19.4 million in repayments on loans held for sale, and net income of $17.8 million.
For the year ended December 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, net of repurchases, from sale of loans held for sale, $25.1 million in repayments on loans held for sale, and net income of $17.3 million.
Investing Activities
For the year ended December 31, 2021, our net cash used in investing activities of $656.5 million consisted mainly of $1.3 billion in cash used to originate held for investment loans, offset by $568.8 million in cash received in payments on held for investment loans and by $135.8 million of proceeds from sales of loans originally classified as held for investment.
For the year ended December 31, 2020, our net cash provided by investing activities of $87.7 million consisted mainly of $343.6 million in cash used to originate held for investment loans, offset by $342.0 million in cash received in payments on held for investment loans and by $99.6 million of proceeds from sales of loans originally classified as held for investment. We used $8.7 million in cash for escrow and corporate advances on loans held in the portfolio. We also received cash of $7.5 million from the sale of REO.
For the year ended December 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 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.
Financing Activities
For the year ended December 31, 2021, our net cash provided by financing activities of $626.2 million consisted mainly of $1.2 billion in borrowings from our warehouse and repurchase facilities and $977.7 million in securitizations issued, respectively. The cash generated was offset by payments we made of $989.4 million and $643.5 million on our warehouse and repurchase facilities and securitizations issued, respectively.
For the year ended December 31, 2020, our net cash used in financing activities of $149.9 million consisted mainly of $420.2 million and $536.7 million in cash from borrowings from our warehouse repurchase facilities and securitizations issued, respectively. This cash generated was offset by payments we made of $766.7 million and $398.3 million on our warehouse and repurchase facilities and securitizations issued, respectively. We received cash proceeds from the sale of our common stock in the IPO of $100.8 million, a portion of which we used to repay $75.0 million of principal on our corporate debt. We also received cash of $41.0 million in net proceeds from the issuance of preferred stock. We used cash of $8.9 million for debt issuance costs.
For the year ended December 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 Loan 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.
April 2020 Preferred Stocks and Warrants
On April 5, 2020, we sold 45,000 shares of Series A Convertible 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 were used for general corporate purposes and to strengthen our liquidity position during the 2020 economic crisis.
The Warrants are exercisable at any time and from time to time, in whole or in part, by the holders until April 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.
On October 8, 2021, we exercised our option to convert all of the 45,000 outstanding shares of Series A Convertible Preferred Stock into 11,688,310 shares of our common stock.
Contractual Obligations and Commitments
As of December 31, 2020 and 2019, including paid-in-kind interest, the aggregate outstanding principal amount of the 2014 Senior Secured Notes was zero and $127.6 million, respectively. In January 2020, we paid down $75.0 million of the 2019 Term Loan with a portion of our IPO proceeds. As of December 31, 2020, the outstanding principal amount of the 2019 Term Loan was $78.0 million. On February 5, 2021, we entered into a five-year $175.0 million syndicated corporate debt agreement (“2021 Term Loan”). The 2021 Term Loan under this agreement bears interest at a rate equal to one-month LIBOR plus 8.00% with a 1.00% LIBOR floor, and matures on February 4, 2026. A portion of the net proceeds from the 2021 Term Loan was used to redeem all the outstanding 2019 Term Loan. The remaining portion of the net proceeds from the 2021 Term Loan was used for loan originations and general corporate purposes.
Velocity Commercial Capital, LLC is the borrower of the 2021 Term Loan, which is secured by substantially all of the borrower’s non-warehoused assets, with a guarantee from Velocity Financial, Inc., formerly Velocity Financial LLC, that is secured by the equity interests of the borrower. The syndicated corporate debt agreement contains customary affirmative and negative covenants, including financial maintenance covenants and limitations on dividends by the borrower.
As of December 31, 2021, we maintained warehouse facilities to finance our investor real estate loans and had approximately $300.1 million in outstanding borrowings with $349.9 million of available capacity under our warehouse and repurchase facilities.
The following table illustrates our contractual obligations existing as of December 31, 2021:
January 1, 2022 -
January 1, 2023 -
($ in thousands)
December 31, 2022
December 31, 2024
Thereafter
Total
Warehouse and repurchase
facilities
$
302,799
$
-
$
-
$
302,799
(1)
Notes payable (corporate
debt)
8,750
17,500
144,594
170,844
Leases payments under
noncancelable operating
leases
1,615
2,613
4,389
Total
$
313,164
$
20,113
$
144,755
$
478,032
(1)Amount represents gross warehouse borrowing. Balance of $301.1 million in the consolidated balance sheets as of December 31, 2021 is net of $1.7 million debt issuance costs.
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
ASU 2019-12, “Income Taxes (Topic 740) - Simplifying the Accounting for Income Taxes.” ASU 2019-12 provides guidance to simplify the accounting for income taxes by eliminating certain exceptions to the guidance in ASC 740 related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and the recognition for deferred tax liabilities for outside basis differences. ASU 2019-12 also simplifies aspects of the accounting for franchise taxes and enacted changes in tax laws or rates and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. ASU 2019-12 became effective for the Company on January 1, 2021. The adoption of this standard did not have a significant impact on the Company’s consolidated financial statements.
ASU 2020-04, “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” ASU 2020-04 provides optional expedients and exceptions for accounting related to contracts, hedging relationships and other transactions affected by reference rate reform if certain criteria are met. ASU 2020-04 applies only to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform and do not apply to contract modifications made and hedging relationships entered into or evaluated after December 31, 2022, except for hedging relationships existing as of December 31, 2022, that an entity has elected certain optional expedients for and that are retained through the end of the hedging relationship. ASU 2020-04 was effective upon issuance and generally can be applied through December 31, 2022. The adoption of this standard did not have a significant impact on the Company’s consolidated financial statements.
ASU 2021-01, “Reference Rate Reform (Topic 848): Scope.” ASU 2021-01 clarifies that certain optional expedients and exceptions in ASC 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. ASU 2021-01 also amends the expedients and exceptions in ASC 848 to capture the incremental consequences of the scope clarification and to tailor the existing guidance to derivative instruments affected by the discounting transition. ASU 2021-01 was effective upon issuance and generally can be applied through December 31, 2022. The adoption of ASU 2021-01 did not have a significant impact on the Company’s consolidated financial statements.

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Intentionally omitted pursuant to smaller reporting company reduced disclosure requirements.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Item 8. Financial Statements and Supplemental Data.
Our consolidated financial statements and the notes related to the financial statements, together with the independent registered public accounting firms' reports thereon, are included in Item 15. Exhibits, Financial Statements and Schedules and are filed as part of this Annual Report on Form 10-K and are incorporated herein by reference.

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Refer to the Current Report on Form 8-K dated May 26, 2021, for discussion of the Company's change in certifying accountant.

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ITEM 9A. CONTROLS AND PROCEDURES
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15(e) and 15d-15(e) under the Exchange Act as of the end of the period covered by this Annual Report. Our disclosure controls and procedures are designed to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including the Chief Executive Officer and the Chief Financial Officer, to allow timely decisions regarding required disclosures. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objective and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
Based on the evaluation of our disclosure controls and procedures as of December 31, 2021, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at a reasonable assurance level as of the end of the period covered by this report.
Management’s Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) for the Company. Our internal control over financial reporting is designed to provide reasonable assurances regarding the reliability of financial reporting and the preparation of our consolidated financial statements in accordance with U.S. generally accepted accounting principles, or GAAP, and includes those policies and procedures that:
•Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;
•Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and
•Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree or compliance with the policies or procedures may deteriorate.
Our management, with the participation of its Chief Executive Officer and Chief Financial Officer, assessed our internal control over financial reporting as of December 31, 2021, the end of our fiscal year. Management based its assessment on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and concluded that our internal control over financial reporting was effective at the reasonable assurance level as of December 31, 2021.
As permitted by the SEC, management excluded from this assessment of internal control over financial reporting the internal control over financial reporting of Century Health & Housing Capital ("Century"). We acquired an 80% ownership interest in Century during December 2021. Century represents less than 1% of our consolidated assets at December 31, 2021.
The effectiveness of our internal control over financial reporting as of December 31, 2021 has been audited by RSM US LLP, our independent registered public accounting firm, as stated in their attestation report, which appears herein in Item 8.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the year ended December 31, 2021 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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ITEM 9B. OTHER INFORMATION
Item 9B. Other Information.
None.
PART III

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ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Item 10. Directors, Executive Officers and Corporate Governance.
Information with respect to this item will be contained in our Proxy Statement for our 2022 Annual Meeting of Shareholders, which is incorporated herein by reference.

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ITEM 11. EXECUTIVE COMPENSATION
Item 11. Executive Compensation.
Information with respect to this item will be contained in our Proxy Statement for our 2022 Annual Meeting of Shareholders, which is incorporated herein by reference.

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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
Information with respect to this item will be contained in our Proxy Statement for our 2022 Annual Meeting of Shareholders, which is incorporated herein by reference.

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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Item 13. Certain Relationships and Related Transactions, and Director Independence.
Information with respect to this item will be contained in our Proxy Statement for our 2022 Annual Meeting of Shareholders, which is incorporated herein by reference.

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ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Item 14. Principal Accounting Fees and Services.
Information with respect to this item will be contained in our Proxy Statement for our 2022 Annual Meeting of Shareholders, which is incorporated herein by reference.
PART IV

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ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
Item 15. Exhibits and Financial Statement Schedules.
(a)The following documents are filed as part of this Annual Report:
(1)Financial Statements
The financial statements filed as part of this Annual Report are included in Part II, Item 8 of this Annual Report.
(2)Financial Statement Schedules
Financial statement schedules have been omitted in this Annual Report because they are not applicable, not required under the instructions or the information requested is set forth in the financial statements or related notes thereto.
(3)List of Exhibits required by Item 601 of Regulation S-K
Incorporated by Reference
Exhibit
Number
Exhibit Title
Form
File No.
Exhibit
Filing Date
3.1
Certificate of Conversion
8-K
001-39183
3.1
1/22/2020
3.2
Certificate of Incorporation of Velocity Financial, Inc.
8-K
001-39183
3.2
1/22/2020
3.3
Bylaws of Velocity Financial, Inc.
8-K
001-39183
3.3
1/22/2020
3.4
Certificate of Designation of Series A Convertible Preferred Stock of Velocity Financial, Inc.
8-K
001-39183
3.1
4/07/2020
4.1
Form of Stock Certificate for Common Stock
S-1
333-234250
4.1
10/18/2019
4.2
Form of Warrant to Purchase Common Stock
8-K
001-39183
4.1
4/07/2020
4.3
Description of the Registrant’s Securities
10-K
001-39183
4.3
4/07/2020
10.1
Stockholders Agreement dated as of January 16, 2020
10-K
001-39183
10.1
4/07/2020
10.2
Registration Rights Agreement dated as of January 16, 2020
10-K
001-39183
10.2
4/07/2020
10.3
Registration Rights Agreement dated as of April 7, 2020
8-K
333-234250
10.1
4/07/2020
10.4
Securities Purchase Agreement among Velocity Financial, Inc. and the Purchasers Party thereto dated April 5, 2020
8-K
001-39183
10.1
4/06/2020
10.5
Credit Agreement Dated as of February 5, 2021, among Velocity Financial, Inc., Velocity Commercial Capital, LLC and Jefferies Finance LLC, as Administrative Agent and Collateral Agent
8-K
001-39183
2/09/2021
10.6
Velocity Financial, Inc. 2020 Omnibus Incentive Plan*
8-K
001-39183
10.1
1/22/2020
10.7
Form of Nonqualified Stock Option Award Notice and Agreement under the 2020 Omnibus Incentive Plan*
S-1/A
333-234250
10.6
1/6/2020
10.8
Form of Nonqualified Stock Option Award Notice and Agreement (Director Grant-IPO) under the 2020 Omnibus Incentive Plan*
S-1/A
333-234250
10.7
1/6/2020
10.9
Form of Nonqualified Stock Option Award Notice and Agreement (Executive Officer Grant-IPO) under the 2020 Omnibus Incentive Plan*
S-1/A
333-234250
10.8
1/6/2020
10.10
Form of Restricted Stock Unit Grant and Agreement (Director Grant) under the 2020 Omnibus Incentive Plan*
S-1/A
333-234250
10.9
1/6/2020
10.11
Form of Restricted Stock Unit Grant and Agreement (Standard Grant) under the 2020 Omnibus Incentive Plan*
S-1/A
333-234250
10.10
1/6/2020
10.12
Form of Restricted Stock Grant and Agreement under the 2020 Omnibus Incentive Plan*
S-1/A
333-234250
10.11
1/6/2020
10.13
Velocity Financial 2021 Annual Incentive Program for Messrs. Farrar, Szczepaniak and Taylor*
8-K
001-39183
8/30/2021
10.14
Form of Equity Distribution Agreement, dated September 3, 2021
8-K
001-39183
1.1
9/7/2021
10.15
Form of Officer and Director Indemnity Agreement
S-1/A
333-234250
10.37
11/6/2019
21.1
List of Subsidiaries of the Registrant
23.1
Consent of RSM US LLP
23.2
Consent of KPMG LLP
31.1
Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
Certification of Principal Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002+
32.2
Certification of Principal Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002+
101.INS
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema Document
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document
*	Management contract or compensatory plan or arrangement.
+	This certification is deemed not filed for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference into any filing under the Securities Act or the Exchange Act.